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Slow Waltz for Australian Ore, Chinese Steel
05-09 16:21 Caijing Magazine comments( 0 )


Years of investment talks between Chinese steelmakers and Australian iron ore miner Fortescue Metals may yield a deal with state-owned Baosteel.

By staff reporters Zhao Jianfei and Li Xin

Australia's third-largest iron ore supplier Fortescue Metals Group (FMG) plans to ship its first boatload of ore to China's leading steelmaker Baosteel in May, following years of investment maneuvering that included the Chinese government while the two companies continue negotiations about a possible tie-up.

Caijing has learned that state-run Baosteel has offered to buy a stake in resource-rich FMG, but an agreement hasn't been reached yet. The talks parallel a Chinese state-owned aluminum company's successful acquisition, with a U.S. company, of a 12 percent stake in Anglo-Australian iron ore giant Rio Tinto -- an FMG rival -- earlier this year.



(Ore extraction site)

But some industry experts are warning the Chinese that costs and risks involved in a potential FMG investment have risen significantly now that its stock price has reached record heights. And Chinese state-owned companies have already missed several chances in recent years to buy stakes in FMG, a company led by Australia's wealthiest man, Andrew Forrest.

Forrest made a quick fortune on the soaring value of FMG stock. Shares in the 5-year-old company have increased vastly on the basis of huge demand for iron ore in China. Some 95 percent of the company's output has been reserved for the Chinese market, and FMG has fastened ties to the mainland by, for example, buying equipment worth AU�� 3 billion from various Chinese manufacturers.

Forrest started FMG through a back-door listing in 2003 and began painting for Chinese steelmakers a picture of a future iron ore giant that could challenge the dominance of Rio Tinto and BHP Billiton, Australia's largest ore suppliers. He projected initial production of 45 million tons per year, and gradually raised the goal to 200 million tons.

But to make the dream come true, Forrest needed cash to build a massive mining and shipping infrastructure. He turned to China for long-term contracts, downpayments and investments.

Small and medium-sized Chinese steelmakers were the first to embrace FMG. In 2004, a steel company in Hebei Province called Wenfeng, with annual production of 2.5 million tons, signed a 20-year contract with FMG for an annual 2 million tons of ore.

Since then, FMG has signed long-term agreements with 35 Chinese steel companies. These include the country's top 10 steelmakers, Russell Scrimshaw, executive director of FMG, told Caijing.

Rising ore prices and long-term agreements with Chinese clients, which cover 90 percent of FMG's initial production plans, have buoyed the company's stock price, which rose to its current level of about AU�� 68 from a mere AU�� 0.10 in October 2004.

Finding iron ore clients has been easy for FMG. But searching for Chinese capital has not.

In late 2004, the Australian company partnered with three Chinese, state-owned construction concerns, including China Metallurgical Construction Group, that offered to build a seaport and a connecting railway to FMG's mines. The deal called for a downpayment from the Australian company of only 10 percent. At the same time, the major Chinese steelmaker Sinosteel was showing interest in an FMG investment.

However, in March 2005, China Metallurgical pulled out of the construction agreement with FMG on grounds that the mining company's resource reserves had not been proven. The building consortium then collapsed, forcing FMG to seek alternative contractors and financing.

Behind the scenes, however, the deal had been wrecked by China's request for a controlling stake in FMG. Sources told Caijing that the Chinese government's National Development and Reform Commission (NDRC) had asked for a stake in the mining company of up to 85 percent, and had asked Chinese enterprises to gang together while negotiating with FMG, stipulating that all deals be cut through China Metallurgical.

History repeated itself in 2006, when FMG knocked on NDRC's door to request an investment. The Australian company put 20 percent of its shares on the table. But the government agency said it wanted nothing short of 50 percent.

At the time, FMG badly needed capital to continue its construction projects. When the Chinese rejected an investment request again, FMG was forced to postpone a scheduled ore shipping date.

FMG found a way around the Chinese wall that same year by borrowing US�� 1.9 billion and securing a US�� 400 million investment from the U.S. holding company Leucadia National Corp., which in 2007 added another US�� 44 million, for what is now a nearly 10 percent stake.

Meanwhile, to the dismay of NDRC, the private Chinese steelmaker Fengli Steel, based in Jiangsu Province, bought a small stake in FMG of 7 million shares. People close to the deal told Caijing that NDRC firstly deemed the deal illegal but, after several months of deliberation, eventually gave it a green light.

Wu Yueming, chairman and founder of Fengli, complained that the NDRC's delay in approving the deal cost him several hundred million dollars.

Now, as FMG prepares to fill seagoing ore carriers with loads of iron for China's steel mills, the Australian company is still interested in Chinese investments. FMG is likely to collect US�� 4.5 billion in revenue by the end of 2008 -- enough to continue infrastructure projects. And a Chinese steel industry source confirmed to Caijing that Baosteel is talking to FMG.

Scrimshaw said FMG still welcomes investors, although he declined to comment on the talks with Baosteel.

�gI can't comment on anything related to equity,�h Scrimshaw said. �gBut as I said, and you would know, China is looking at projects around the world to secure its long-term supply. And if China is looking at projects around the world, we think ours is the best.�h

Nevertheless, Scrimshaw said his company insists on maintaining controlling rights. �gWe control nearly 50 percent of the company,�h he said. �gIt's important for us to keep that because we don't want someone to bid on the market and take us over.�h

While negotiations continue, some Chinese voices are urging caution. One industry insider told Caijing that investing in FMG would no longer be advisable given the stock's high price. China may have lost its chance to profit from FMG's boom on the stock market.

�gNot only China missed a chance. There are a lot other investors who now are kicking themselves,�h Scrimshaw said. �gBut it's not too late to invest in FMG through the open market.�h


Q&A with FMG Chairman Andrew Forrest and Executive Director Russell Scrimshaw

(April 12, 2008)

CJ: When FMG starts shipping in May, is the first load going to China? If so, to which steelmaker?

Forrest: We heard rumors that the railway line (from the FMG mines to a seaport) won't be finished until July or August this year. We in fact finished the railway line and unloaded the first iron ore last week (early April). So that�fs done. The first shipment will go to Baosteel.

Scrimshaw: Our first several ships will go to the top 10 steelmakers in China. And these are going to be big, 160,000 to 190,000 ton ships. We will step forward slowly in the first several weeks. We don�ft want to overstress our equipment on day one. We want to use them properly. But we expect pretty quickly, in June or July, we will be shipping 2 million tons a month to China. By December, we expect to ship 4 million tons to China.

CJ: Will price negotiations affect the shipping date?

Forrest: No. Back in 2003 when we started the company, we were guided by two things: one, we think China will have a great demand for resources, especially iron ore; and two, Pilbara (a mining area in Australia) is very inefficient, and it needed competition. Pilbara has BHP (Billiton) and Rio Tinto in it. And they had ports and railways, which are under-utilized. So we came in and gave them competition. In so doing, we now have a major iron ore supply for China.

CJ: When you ship iron ore to China in May, what will your price be for ore if the negotiations are still ongoing?

Forrest: We just go by whatever is the established price. We are not price setters. Our job is to sell as much as possible because our customers are screaming for the iron ore; they are screaming for new supply. Whatever the set price is, we are happy to accept that.

CJ: Will FMG join price negotiations in the future?

Forrest: I don't see anything wrong for Fortescue in doing that. We are very happy to help our customers and companies. But at this time, we don't have to speculate. What we know is that we can help our customers dramatically increase the supply.

BHP and Rio Tinto currently control the supply of iron ore to China, and they only sell 50 percent or less of their iron ore to China. So we are selling all our iron ore to China. If you add up what they are selling to China, 130 to 140 million tons maximum, we have the capability to double that.

CJ: Is Baosteel buying a stake in FMG?

Scrimshaw: I can't comment on anything related to equity. But as I said, and you would know, China is looking at projects around the world to secure its long-term supply. And if China is looking at projects around the world, we think ours is the best.

CJ: When will FMG take over and beat BHP and Rio Tinto to become the largest iron ore supplier to China?

Scrimshaw: Half of what BHP and Rio produce in iron ore doesn't go to China; it goes to long-term customers in Taiwan, in Japan and in Korea. And in the case of Vale (a Brazilian ore supplier), it goes to Europe. So while they sell a lot to China, they still have their long-standing relationships. BHP manufactured, produced 120 million tons last year, I think. About half went to China, 60 million tons. FMG next year will export that much to China. So I can't answer your question directly other than to say we expect next year we will be as big a supplier as the two majors are.

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