.....the fight goes on.....
Mar 29 2015 at 3:46 PM
Fortescue Metals fights on against iron ore market 'flood'
by
Jennifer Hewett
Andrew Forrest was one of the few world business leaders to have meetings with China's Xi Jinping at the Boao Forum over the weekend. It's one more sign of the reach of Forrest's extensive connections with the highest levels of Chinese political leadership, established over many years.
But such relationships can't help Fortescue Metals Group with a very basic iron ore problem right now. That problem is when and whether the price for iron ore will lift from lows far deeper and more persistent than Forrest and Fortescue expected at the time of last year's forum.
The 2015 forum, for example, included the head of research at Baosteel saying he personally expected the bear market for iron ore to last at least another four to five years due to massive expansion of supply overwhelming demand in China.
Fortescue doesn't agree with this gloomy (at least for Australia) assessment on how long it will take for new supply of iron ore to be absorbed. Chief executive Nev Power remains confident of strong demand for steel in China and elsewhere in Asia for decades to come in order to underpin the necessary infrastructure-building and further urbanisation.
Yet he still believes that even today's low prices are likely to fall further in the short term. That's because, he says, the market is being driven by sentiment.
"Everybody is expecting it to go down; everybody is reacting to the constant apprehension of oversupply," Power says. "We have two of the biggest suppliers in the world saying they are going to flood the market. I think the market is responding to that."
Fortescue blames this on the absence of any "rational behaviour" by BHP Billiton and Rio Tinto in continuing their drive to expand production no matter the impact on prices.
Dinner talk attracts ire
The company's frustration with this was behind Andrew Forrest's off-the-cuff suggestion at a dinner in Shanghai last week that there should be an agreement between the major producers to cap production levels.
Such a notion was clearly a nonsense and very clumsily phrased. It instantly attracted the ire of the Australian competition regulator, Rod Sims, as well as the mockery of Sam Walsh at Rio Tinto.
But Fortescue maintains its view that what is effectively a joint BHP and Rio strategy on continuing to increase production is bad for everyone – including Australian taxpayers. It's a sentiment loudly backed by West Australian Premier Colin Barnett, among others.
And while Treasurer Joe Hockey is adamant about the evils of cartels, he acknowledges the dire impact on the federal budget of an iron ore price so much lower than Treasury predicted.
At about $US55 a tonne, that also makes balancing the budget much tighter for Fortescue given it has higher overall costs than Rio and BHP. Fortescue's costs, including interest on debt, are about $US45 a tonne. It also receives a discount of about 10 to 15 per cent on its ore, given it is of slightly lower quality. That only leaves a margin of a few dollars.
According to Power, Fortescue's costs will go down by another $US5 to $US6 a tonne by June, meaning it will outpace any further drop in iron ore prices over this year. But that doesn't make adjustment to the new commercial reality easy. Nor does it give investors much comfort – as is obvious in Fortescue's share price.
It didn't help sentiment when the company pulled a $US2.5 billion ($3.2 billion) bond issue in the United States after failing to get the right pricing. The plan had been to extend the maturity of some of its $US9 billion in debt and potentially lower its interest costs.
Fortescue still doesn't have to make further repayments until 2017 but market confidence was shaken by the episode, especially as it came just after another withdrawn attempt to tap US loan markets.
Stockpile edges up
Market apprehension is compounded by doubts about whether iron ore prices can ever recover at least some of their former glory days. Of that, there's absolutely no sign at the moment.
Even the huge iron ore stockpile, which had been slowly falling, has edged up again in recent weeks after a couple of provinces shut some steel mills because of pollution. This, along with China's slowing growth, has had a ripple effect on short-term demand for iron ore for steel production.
Even without those sorts of fluctuations, BHP and Rio insist that if they don't increase volumes, other major international players – such as Brazil's Vale – will simply fill the demand by escalating their own production.
Not surprisingly Power disagrees, arguing that Vale too must find it hard to justify a further $US20 billion in investment for a planned new mine. "I don't believe anybody else will [increase production] at prices even significantly above where they are today," he says.
"So why would you deliberately drive prices down? Why would you destroy returns for your own shareholders as well as for your industry, your state, your country to grow market share by aggressively expanding?"
He also dismisses the criticism that Fortescue shares responsibility by increasing its own production dramatically from zero in 2008 to about 165 million tonnes a year today. According to Power, it's not past investments but announced future increases by BHP and Rio that are the real issue now.
Fortescue has never doubted its ability to withstand the pressure from its larger Australian competitors and the constant scepticism of Australian analysts since Forrest turned his dream into reality.
Even at today's prices, Power says, the company has $450 million to $500 million of free cash flow a year while its costs will continue to decline. "We have got brand new infrastructure, we have great assets, we are cash positive and we have no debt due until 2017," he says.
"We have about $1.5 billion in the bank which is not a bad fighting fund, and we have identified projects to drive our costs down further and to stay ahead of the market going forward. So there's no question we can outlast whatever the market throws at us. But what we are saying is it doesn't have to be this way."
Given that it very much is this way, however, Fortescue is investigating the possibility of investors, probably Chinese, taking a stake in some of its mines. Power prefers to call this responding to "opportunities" rather than to market pressure. And for all his frustrations, Forrest's optimism about "opportunities" never falls far.
