It was supposed to be a rare moment of vindication at Citic Pacific’s $US10 billion ($11 billion) iron ore mine in Western Australia. Yet as the commissioning process swung into action it soon became apparent that something was badly wrong.
The barge was not in place. So, instead of that precious load going to China, it literally missed the boat, and ended up at the bottom of Cape Preston Harbour.
“It was only a very small amount,” said a spokesman for Citic.
Regardless, it was an inauspicious moment which has come to represent the woes of this giant project in the Pilbara. But it’s hardly the biggest concern facing Citic’s government owners in Beijing.
From the outset in 2006, the so-called Sino Iron project was foreign policy dressed up as commerce. That’s a bad combination and it has cost the Chinese people and Citic’s Hong Kong-listed subsidiary dearly.
When the first load of iron ore was finally shipped in December last year the mine was four years late and at least $6 billion over budget. Yet despite the cost over-runs, legal battles and delays, the project’s future is still not guaranteed.
When Clive Palmer, who owns the mining licence, launched legal action on Friday to wind up Citic’s Australian subsidiary, which operates the mine, he was just the latest person to question its solvency.
Palmer, the abrasive entrepreneur turned federal MP, speculated in his media release that Citic may have stopped advancing funds to its Sino Iron subsidiary.
“Mineralogy [Palmer’s main company] is concerned that Sino Iron is unable to pay its debts when they fall due,” he said.
Palmer is hoping to have this claim tested by the Federal Court in Perth. If this happens – and there is no guarantee the court will agree to hear the action – it will surely make for some ugly reading.
For Sino Iron and Citic are a mess.
Tim Murray, the managing partner of Beijing-based research firm J Capital, has provided a preview of sorts for what the court might be told regarding the viability of Sino Iron. But unlike Palmer, Murray does not believe the problem is Citic withholding cash from its Australian subsidiary. He questions if Citic has any cash left. The title of his research report, distributed to hedge fund clients on February 4, made the point succinctly: “Citic Pacific: no way to survive.”
Murray says the Hong Kong-listed Citic has been selling assets ever since it inked the deal with Palmer to build and operate the mine in 2006. Citic said these sales would allow the company to “focus” on its core business which is now iron ore.
Murray does not buy this line. “We see it more as a desperate attempt to raise capital to keep the group solvent,” Murray wrote.
He said Citic had raised $HK21.6 billion ($3.1 billion) from asset sales since beginning its iron ore adventure and could raise a further $HK20 billion by selling everything else. But this would only cover 25 per cent of the debts racked up by the iron ore division.
‘UNLIKELY TO EVER MAKE MONEY’ This would not be a problem if Sino Iron was throwing off cash, which brings us to the central point of Murray’s report. He believes the mine needs an iron ore price of $US158 a tonne to repay its debt, meet interest payments and account for depreciation. This is well above the current price of $US130 a tonne and long-term projections of around $US90 a tonne.
“We believe Citic Pacific’s iron ore division is unlikely to ever make money,” he says. “Even if the mine were debt free and all the assets written off, this low-quality mine would not be worth operating.”
Citic would not comment, as it is in a “blackout” period ahead of releasing its financial results. However, Murray’s analysis is a major problem for Palmer and neatly demonstrates the delicate situation in which the Queenslander has found himself.
He needs the mine to be operational, which is why his legal action on Friday to wind up Sino Iron is somewhat contradictory. If the mine shuts down, as Murray has predicted will happen in 2015, then Palmer’s $250 million in annual royalties will likely be the subject of protracted litigation.
When contacted on Friday, Palmer disputed the claims made by Murray.
“Once they [Citic] are in full production they should be able to make a good profit and even repay the debt,” Mr Palmer said by phone. “They are not going to shut the mine as they have persevered with it for this long.”
This appears to be his main hope. He’s betting that having gone to the pain and expense of building the mine, Citic won’t shut it down even if it begins to wrack up substantial losses. This is where Beijing’s foreign policy comes into play. When it embarked on this investment the aim was to get another player into the market and therefore make China less reliant on the three big Australian players – Rio Tinto, BHP Billiton and Fortescue Metals Group – and Vale of Brazil.
At the time Beijing was panicked that China’s development would be stymied by persistently high iron ore prices. And so it got involved with Palmer. Beijing believed bringing on a new supplier would cost it around $US3.5 billion. It was a hedge and a relatively cheap one at that. Yet that number quickly doubled and then on some estimates may nearly double again.
Mr Murray said Citic’s iron ore division has debt of $US5 billion, while the group had further liabilities totalling $US9 billion. “We believe the debt associated with Citic’s iron ore mine is in the range of between $US10 billion and $US12 billion,” he said.
This is at the high end of the range, but not a crazy number. Goldman Sachs estimates Citic’s investment in the Sino Iron project will eventually reach $US11 billion.
“We didn’t understand actually how to develop a large-scale mine in Australia,” Citic chairman Chang Zhenming said in the latest issue of Chinese business magazine Caixin. “We seriously underestimated the construction project’s difficulty.”
Chang admitted the company had no idea about Australian labour costs, building standards and even the level of accommodation miners would demand. At every turn it underestimated costs and complexity. It originally budgeted $US30 million for the construction of worker accommodation, before realising Australian miners won’t bunk down 20 to a room. It also had to replace much of the plumbing and wiring in the accommodation blocks as they didn’t meet Australian standards.
These and many other problems saw the original $US30 million accommodation budget become $US300 million. It is these type of wild cost escalations that may eventually see Citic spend $US12 billion on the project. “It’s our single largest foreign investment in Australia,” one Chinese national remarked wryly.
HOPING FOR A BAILOUT Such a huge investment has crippled the Hong Kong-listed Citic Pacific. If Palmer’s suspicions and Murray’s analysis are right then it will require a bailout from its Beijing-based parent Citic Group, a state-owned enterprise.
Palmer is clearly betting that Beijing will do exactly this, partly to save face and also to fulfil its original aim of bringing down the iron ore price. That might be the case, but Palmer’s aggressive legal tactics and overblown rhetoric can’t be helping. Last week he accused China of “stealing Australian resources”, the latest tirade of abuse directed at Citic. Then he told The Australian Financial Review that corruption was behind the huge cost blowouts at the mine.
“We had a quote to build it for $US5 billion. The cost over-runs are unexplainable,” he said. “We know the new president [Xi Jinping] is cracking down on corruption so [Citic] can expect to have their bottoms smacked.” “They can expect to have their bottoms smacked,” he repeated for a second time, in case the point was missed.
Citic has been far less colourful in its characterisation of Palmer. Chang told the Melbourne Mining Club last week, Palmer is “larger than life”.
We’re sure Chang and his masters in Beijing would be less diplomatic in private. This is the issue for Palmer, which raises a far bigger question. Will Citic tire of Palmer’s aggressive legal tactics and grandstanding in the press and simply walk away? It would be a huge “loss of face” but one that could be justified given the changed circumstances.
When the investment decision was made, Beijing was facing heightened strategic competition for resources. With new supplies of iron ore coming online and China’s own development slowing down, the Sino Iron project is no longer of vital national importance.
And shutting down the project would also give Beijing the added satisfaction of potentially depriving Palmer of at least $250 million a year in royalties.
That might ease the loss of face.
ARH Price at posting:
4.2¢ Sentiment: None Disclosure: Held
