priced for failure

Ocean's report today says it all - the best iron ore juniors are 'priced for failure' - three words that says it all about the current market .... sit tight!

News
Following Australian Federal Treasurer Wayne Swan’s trip to the Pilbara on the weekend he has officially declared the Hamersley and Robe railway lines owned by RIO, and the Goldsworthy railway line owned by BHPB, under the Trade Practices Act enacting recommendations from the National Competition Council (“NCC”).

Fortescue first launched a bid to declare the rail lines open in 2004 and today’s announcement is another significant break-through for the junior sector following the previous treasurer, Peter Costello, failing to accept a similar NCC recommendation in March 2006. Under today’s NCC recommendations iron ore juniors are able to apply for right of access for 20 years, starting November 19th 2008, and will have the right to run their own locomotives and rolling stock on existing rail lines, subject to negotiating commercial agreements. A safety network is provided to the juniors such that recourse to regulation through ACCC arbitration is available if access disputes cannot be resolved.

Meanwhile, Fortescue has confirmed the commissioning of a study assessing the viability of a second iron ore port at Dixon Island near Karratha. The port would be for the development of the company's western tenements, including Solomon, and could be fed by RIO’s rail lines once commercial terms are agreed.

Implications
The move from Wayne Swan further illustrates the increasing pressures from government and industry on the traditional incumbents, BHPB and RIO, to open up their existing rail networks and provide 3rd party access to emerging iron ore juniors. While we would expect BHPB and RIO to seek a review of the declaration (“Summary Timeline” provided below), we believe it is now only a matter of time before the juniors have access to the majors existing rail infrastructure and see the ability of the juniors to negotiate with existing infrastructure owners in the Pilbara as being significantly enhanced by today’s break-through development.

The magnitude of Swan’s announcement can be seen in BHPB and RIO’s opening share prices which collapsed ~7% at the open in London, following a flat trading day on the ASX and the announcement of the declaration of rail services only after the close of the ASX. The proposal of full rail track services, not just 3rd party haulage, has a significantly greater potential impact on the efficiencies of the incumbent’s integrated networks, key criteria to the proposed synergies of a BHPB/RIO merger (and for a junior to agree a commercial agreement with a major).

A further positive for the junior space is the Government’s conclusion that while port capacity may be some what constrained in the short term, that medium and long-term infrastructure plans for port capacity (and common user facilities for relatively small tonnage bulk commodity exporters) are sufficient not to impeded 3rd party rail access or capacity allocations.

We believe juniors who are close to existing (or future committed) rail infrastructure, with high grade deposits (suitable for blending with BHPB & RIO’s existing operations), are best positioned to negotiate near term infrastructure access or other forms of commercial agreements (eg mine gate sale, JV etc). We would expect iron ore juniors with “stranded” deposits (such as FerrAus), and potentially large scale operations (such as Brockman, UMC, and Atlas), to best benefit from today’s announcement. Additionally we would highlight that at the current share prices a number of these juniors are priced for failure or limited scale operations (with no rail access).

Summary Timeline
29th Aug’08 - NCC’s provides Australian Federal Treasurer, Wayne Swan, their final recommendations for the Hamersley, Robe and Goldsworthy railway lines.
27th Oct’08 - Swan accepted the NCC recommendation and declared the service for a period of 20 years.
19th Nov’08 - Service providers deadline for seeking a review by the Australian Competition Tribunal, if no review is sort 3rd party’s can apply for right of access from this date. We believe BHPB and RIO will seek a review under which the Australian Competition Tribunal must use its best endeavours to determine any review of the Treasurer's declaration within 4 months, although that period may be extended (as per the current review of the Mt Newman railway line).