king report, page-2

ANALYSIS OF PROJECT FOR
IRON ORE CONCENTRATES, PELLETS
AND DIRECT-REDUCED IRON
IN WESTERN AUSTRALIA
Project 1B
11.5mt Concentrate, Pellet and HBI at 2006 Prices
prepared for:
Australasian Resources Ltd
June 2006
This report is for the use of the parties
in the Australasian Resources project
and their holding companies
INTRODUCTION
This report has been prepared by James F. King1 for Australasian Resources Ltd. Its purpose is to present an independent analysis of a project for the production of iron ore pellets, concentrate and direct-reduced iron in Western Australia.
The report is in three sections. Section 1 describes Australasian Resources’ project (the project). Section 2 assesses the competitive position of the project with regard to operating costs. Section 3 analyses the financial viability of the project under specified assumptions.
All monetary values in this report are in US dollars. The analysis has used an exchange rate of A$ = US$ 0.78.
THE PROJECT AND ITS COSTS
The project is an iron ore mine, concentrator, pellet plant and direct-reduced iron plant in Western Australia, with proposed finished product sales of 5.2 million tonnes per year (t/y) of iron ore concentrates, 4.9m t/y of iron ore pellets and 1.45 t/y of HBI (hot briquetted iron), a total of 11.55m t/y of finished products.
The project is based on mining rights over part of the George Palmer Orebody, part of the Fortescue iron ore deposit, located 80 kilometres south of Dampier in the Pilbara region of Western Australia. The iron ore reserves available to the project are of the order of 1 billion tonnes.
A new open-pit iron ore mine will be developed to extract ore with magnetite content as mined of approximately 31.9%, equivalent to 23% magnetic iron. The mine will be designed to yield about 41m t/y of iron ore. At this mining rate, the life of the project would be a minimum of 24 years. Total material moved, including waste, will be about 63 million t/y.
The mine will be operated by a mining contractor. The contractor will deliver crushed ore by conveyor to a concentrator close to the mine site. In the concentrator the ore will be mixed with water, ground to fine sizes in rod or ball mills and upgraded by magnetic separation and flotation to produce an iron ore concentrate containing 70.7% iron. Waste material from the concentrator will be pumped to a specially designed tailings disposal area in compliance with good environmental practice. The concentrator will have a capacity of about 12m t/y.
The plant will have the capability to produce concentrates suitable for producing iron ore pellets used in direct reduction plants or blast furnaces. The grades of concentrate expected from the plant are some of the best in the world. The key parameters for iron ore products include high iron content and low content of the impurities alumina, silicon and phosphorus. Appendix 1 shows a comparison of the project’s grades with the grades of other major iron ores in the international market.
1 James F. King is an independent consultant specialising in the economic aspects of the iron and steel industry. Since 1982 Mr. King has maintained and published comprehensive information on capacities by plant. Regular reports with forecasts of the markets for steel and iron ore have been supplied to the industry and consultancy projects carried out for major companies around the world. Mr. King also maintains information on production costs for iron ore and for iron and steel and is the author of the regular service on steel costs published since 2000 by Metal Bulletin Research, London. Mr. King also contributes items on iron and steel to the regular services of the Economist Intelligence Unit, London and to the major steel industry internet website: www.steelonthenet.com. 1
It is expected that 5.2 million t/y of concentrates will be sold as a finished product to pellet plants without sufficient iron ore supply from their own mines. The remaining iron ore concentrate will be processed at the mine site to pellets. In the pellet plant the fine-ground iron ore concentrate will be mixed with an organic binder and dolomite, formed into pellets and fired (indurated) using a modern straight-grate process fuelled with natural gas. The magnetite content of the iron ore provides energy for the pelletising process and reduces fuel consumption. The product will be a structurally strong iron ore pellet with iron content of 68.1% and low levels of impurities. The plant will have the capability to produce pellets for use in direct reduction plants (requiring low silica) and blast furnaces. For market reasons, explained below, production will be of blast furnace pellets and that is the basis of this evaluation. The pellet plant will have capacity of 7.0 million t/y.
It is expected that 4.9m t/y of pellets will be sold. The remaining pellets will be processed at the site to direct-reduced iron by a direct reduction process using natural gas. The DRI plant will have one module, with capacity of 1.45m t/y. Because of long-distance shipment will be in the form of HBI (hot briquetted iron).
Products will be delivered by a 30 km overland conveyor to a new port at Cape Preston on the Indian Ocean. The port will be developed to handle and load ships from 20,000 to 175,000 deadweight tonnes. It is assumed that the capital costs of the conveyor, materials handling equipment, port and associated dredging will be paid one third by Australasian and the remainder by other users. Process water required for the project will be supplied from a borefield or desalination plant. Electricity for the project will be supplied from a gas turbine power station using natural gas.
Including engineering, project management and miscellaneous items, the total capital costs for the project will be 1863 million US dollars. The details are shown in Appendix 2, Table 5. The sources of these cost estimates are turnkey bids for the Balmoral Central Block updated to 2006 prices from the key contractors and equipment suppliers for each stage, adjusted for the proposed scale of the project.
COST COMPETITIVENESS
Using information from the Engineering for the Balmoral Central Block project, the operating costs of each stage of the project have been assessed. These are summarised in Appendix 2, Table 1 and detailed in the subsequent tables of that Appendix.
The average operating costs at the plant is expected to be $18.76 per tonne for concentrate and $25.09 per tonne for pellets. Including delivery to the port, shiploading, administration and royalties, the operating cost, FOB on a ship at the port, is expected to be $24.41 per tonne for concentrate and $30.73 per tonne for pellets. For concentrate this is equivalent to 35.91 US cents per dry metric tonne unit of iron (the conventional measure of iron ore prices) and for pellets 45.58 cents/dmtu.
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Operating Costs of Iron Ore Pellet Plants, 2004
(US cents per dry metric tonne unit, FOB shipping point)
Product
Average
Lowest 25%
Project
Pellet feed fines
25.1
< 16.6
35.91
Pellet
53.6
< 50.6
45.58
Source: Iron Ore Production Costs, James F. King, 2005
Information on the costs of production of existing iron ore operations around the world is maintained and published by King. These indicate that the expected operating costs of the project are highly competitive for the production of pellets. King’s information shows the average operating cost for traded iron ore pellets (i.e. excluding pellets used entirely within integrated steel companies’ own operations) in 2004 as 53.6 cents/dmtu, FOB on a vessel at the shipping point, and the lowest-cost 25% of capacity had operating costs below 50.6 cents/dmtu FOB. The project has operating costs of 45.58 cents/dmtu, among the lowest in the world.
These fundamentally low iron ore costs are carried forward to DRI production. Data for the second quarter of 2006 shows that the average cost of production for direct-reduced iron was $149 per tonne, FOB plant. Most of the plants competing in the export market for DRI are the lower-cost producers. The lowest-cost 25% of capacity for DRI has costs below $100 per tonne. The project has operating costs, FOB plant, of $81.31.
DR Iron: Production Costs50709011013015017019021023025005101520253035404550556065707580859095100Cumulative Capacity, percentProduction Costs, $/tonne507090110130150170190210230250world operating costsoperating cost curveproject costsProject cost = $81industry average cost = $149
FINANCIAL ANALYSIS
Capital and Operating Costs
Total capital costs of $1863 million and average operating costs per tonne shipped of $35.20 are taken from the analysis described above. Capital costs are allocated across a 30-month construction period. There is no major replacement of equipment over the life of the project and no residual value (recovery value) is realised at the end of the project.
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Revenues
Revenues are calculated as the volume of sales (11.55 million tonnes per year) multiplied by the average FOB price of products.
Competitive market prices for the iron ore products of the project are estimated in Appendix 2, Table 6. The market for iron ore is currently very strong and China is importing a massive quantity of iron ore. In the years to come we expect that the Chinese imports of iron ore pellets and concentrates for domestic pellet plants will expand greatly. We therefore believe that the project’s main market would be China, with potential sales also in other Asian markets such as India. Because China has very little demand for DR pellets, imports of pellet into China would be all BF pellets. Sales of DR pellets would be made to nearby consumers, such as Indonesia, India or the Middle East when these are more profitable than BF pellets. The project is evaluated on the basis of all pellet sales as BF pellets
It is assumed that customers can receive ships up to 150,000 tonnes. If customers are limited to smaller ship sizes, the project is more competitive against long-distance iron ore suppliers and the average product prices would be higher.
In February 2005 a new price for iron ore fines was agreed with key buyers, raising the price by 71.5% for 2005. In March 2005 a new price for pellets was established, with an increase of 86.7% to a base price of 115.51 cents/Fe unit, equivalent to $74.67 per tonne FOB Tubarao, Brazil for CVRD’s pellet.
Allowing for the higher quality of the project’s pellets and the freight cost advantage for the project in shipping to its markets, the project would be competitive at a selling price for blast furnace pellets of $92.58 per tonne FOB in 2005.
Because of the quality of the project’s ore the competitive price of pellet feed concentrate was taken as the price of sinter fines, FOB Australia plus 5%. The base price used was Hamersley Iron’s export price to Asia of 61.72 c/dmtu. Allowing for the quality of the project’s ore, this was equivalent to a market price of $43.99 per tonne in 2005.
In May 2006 a new price for iron ore fines was agreed with key buyers, raising the price by 19.0% from 2005. A new price for pellets was also established, with a reduction of 3.0%. For 2006 the benchmark price of BF pellets is a base price of 112.04 cents per Fe unit, equivalent to $72.43 per tonne FOB Tubarao, Brazil for CVRD’s pellet. Allowing for the higher quality of the project’s pellets and the freight cost advantage, the project would be competitive at a selling price for blast furnace pellets of $90.24 per tonne FOB in 2006.
The competitive price of pellet feed concentrate was taken for 2006 as the price of sinter fines, FOB Australia plus 5%. The base price used was Hamersley Iron’s export price to Asia of 73.45 c/dmtu. Allowing for the quality of the project’s ore, this was equivalent to a market price of $52.34 per tonne in 2006.
The market for steel scrap was very strong in 2004 and 2005. International prices for DRI follow the prices of steel scrap, with which it is direct competitor. For analysis a current market price of $240 per tonne has been used for DRI, applying to 2005 and 2006.
For the purposes of this report the competitive 2006 prices have been used.
At this stage it is not assumed that there are equity partners of this kind and all sales are at market prices. The market prices used, and resulting average selling price per tonne of product shipped, are:
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Base Selling Prices - 2006
(US dollars per tonne, FOB shipping point)
Product
Price
Pellet feed concentrate – market price
42.34
BF pellets – market price
90.24
DR pellets – market price
-
DRI/HBI – market price
240.00
average selling price
91.98
Taking account of the volumes sold at market and discount prices, the average selling price for the project’s production will be $91.98 per tonne FOB.
Inflation
Inflation is assumed to proceed at 1.9% per annum throughout the period and all calculations are made in nominal terms.
Project Life and Depreciation
Given the quantities of iron ore reserves available, the project is evaluated over an economic life of 25 years after construction. Assets are depreciated over 20 years for commercial purposes and over 10 years for tax purposes.
Financial Structure
For the whole project, long-term loans are assumed to be equal to 70% of the capital cost, drawn down in equal parts (in real terms) in years 1 to 2. Short-term loans cover stocks and work in progress. Loan principal is not repaid until the loan drawdown period is over. Beyond that there is no repayment holiday. The interest rate is 6.0% per annum. It is assumed that all the company’s available cash flow will be paid out as dividends, subject to the company meeting all payments of debt principal and interest and having adequate cash reserves for operation at all times.
Results – Total Project
The results of the financial analysis are shown in Appendix 2, Table 1. Appendix 2, Table 8 presents a complete print of the financial model over its whole life, from which the results for the total project and the partners are calculated. These are summarised in the tables.
Australasian Resources: Results for Total Project 1B
Item
Return on equity before tax
%
48.7
Return on equity after tax
%
41.0
Earnings after tax in:
first year of full operation
$m
370
first 10 years of full operation
$m
4285
NPV after tax at 8% in Year 1
$m
3534
NPV after tax at 8% in Year 5
$m
5340
Market valuation in:
first year of full operation
$m
4437
Year 10
$m
5379
The total project shows a rate of return on equity of 48.7% per annum before tax and 41.0% per annum after tax.
The table also shows the financial results of the operation. This indicates profits after tax of $370 million in first year of full operation and cumulative profits after tax for the first ten years of full operation of $4285 million.
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Net present values (NPV) are also shown. These are the net present value of equity cash flows after tax calculated at various rates of discount. For example, at 8% discount the NPV after tax in Year 1 is $3534 million. If the NPV after tax is calculated at Year 5, it increases to $5340 million.
Financial ratios are also shown in Appendix 2, Table 8. The long-term debt service cover ratio2 over the life of the loans is generally in the range of 4 to 9 and is positive in all years after construction. The loan life cover ratio3 is generally 7 to 13 and not less than 7 throughout the remaining life of loans. These are very strong financial ratios indicating that long-term debt can be comfortably serviced.
If the shares of the project company were traded on a stock exchange, the company would have a market valuation equal to the number of shares multiplied by the share price. In order to estimate a reasonable share price for a company, it is normal to consider the price/earnings ratio for companies of the same type and to multiply that ratio by the earnings of the company after tax. In late 2004 leading financial analysts were expecting a price-earnings ratio for major mining companies of 12.0 over the period to 20084. Using that ratio and the forecast earnings after tax of the project company, Appendix 2, Table 8 shows that the project company would have a market valuation of $4.4 to $8.1 billion over the first 20 years of full operation.
JAMES F. KING
6 June 2006
2 Cash flow from operations less tax as a ratio to the debt interest and principal payments in each year
3 The net present value of cash flows over the remaining life of loans as a ratio to the total of outstanding loans in any year
4 This is based on a published report by Morgan Stanley Equity Research of November 2004, forecasting a weighted average of the price/earnings ratio of 12.0 over the period 2005-2008 for the major quoted international mining companies: BHP Billiton, Rio Tinto, Anglo America, Norilsk, Xstrata, Lonmin, Antofagasta and Vedanta.
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