It's official: $1.2bn deal makes Twiggy the third force in iron...

It's official: $1.2bn deal makes Twiggy the third force in iron ore
Rowan Callick, China correspondent
May 21, 2007

ON a blustery day in Beijing last week, in the Great Wall Sheraton hotel, the unthinkable became the inevitable.
The signing of a $1.2 billion a year contract on Thursday confirmed that Andrew Forrest, the silver-spoon upstart, will around this time next year emerge as not just a paper billionaire, not just a figure of controversy, fear and fun, but as the third force in Australian iron ore.

It might still seem drab to those thrilled a decade ago by the concept of a "new economy", it might even be disliked by those Australians who find mining altogether distasteful. But there is no bigger game in town than iron ore.

Last year we sold $7.6 billion of it to Chinese steel mills - our largest single export item by a very long way.

As long as "Twiggy" Forrest can prove up his 932 million tonnes of ore now classed as "probable", his mine in Western Australia's Pilbara now looks unstoppable. This is an outcome on which many banks and other investors have bet the $3.7 billion it is costing to build Fortescue Metals Group's mine, railway and port there.

His contract with Tangshan Iron & Steel Group for up to 20 million tonnes of iron ore a year follows a similar deal signed with Baosteel in March. They are respectively China's third and top steel producers, and these are the two biggest single deals, in annual production terms, that any Australian firm has yet signed, surpassing even the liquefied natural gas contract with China, albeit that one was very charitably priced.

Fortescue has also signed smaller contracts with Wuhan Iron & Steel for up to 7 million tonnes per year and with Fengli for 4 million tonnes per year.

Forrest could still come unstuck personally, as the Australian Securities & Investments Commission continues to press charges that he deceptively claimed in 2004 to have secured "binding" funding and construction contracts with Chinese partners.

But FMG seems set to survive even a personal defeat for Forrest at the hands of ASIC. The new contracts are kosher. And progress on the mine last month improved 6-7 per cent, Forrest said in Beijing, while the port was 3-4 per cent ahead of schedule - although construction of the railway has been set back by three cyclones.

As a result of the ASIC case, Forrest said in Beijing: "We have lost time we will never recover - but the company has been able to get on with its life and raise money, still with the absolute and utter support of China. I don't have any regrets."

Wang Tianyi, the chairman of Tangshan, which is based in Hebei province 150km east of Beijing, said at the signing ceremony that "for us, Fortescue is an old friend, from the earliest stage" in the project.

"When everyone was wondering whether it was going to be successful, we believed Andrew Forrest and his team would be a success."

He said the company aimed to be the top steel mill in the world, and that FMG would be its "preferred partner" in this drive.

That helps explain how Forrest has recovered from that row - which seemed crippling at the time - with his three former Chinese partners, led by China Metallurgical Construction Corp.

The Chinese players are all ultimately government-owned, and must in extremis respond to policy dictated at the highest levels in China. But in many day-to-day operations, they behave - and have the personal incentives to behave - extremely competitively, even jealously.

So the situation is not like Japan Inc where in the past private firms have tended to collude and walk in lockstep under the guidance of powerful officials. In China, state firms often give lip service to officialdom while seeking to maximise their own autonomy, and above all to come out as top dog against their domestic rivals.

The ore shipped by FMG to Tangshan, Baosteel and the others will be bought at the price benchmarked by the annual contracts negotiated between the three biggest producers, BHP Billiton, Rio Tinto and Brazil's CVRD, and the major international steel mills.

Forrest said: "We get a lot of pressure to break away from the benchmark. When the price goes down, buyers love it, and when it doesn't they don't. It's a fair instrument.

"We're happy to be a volume competitor and a price follower." Especially since the price has kept leaping in each of the past four years, and most analysts are forecasting a further 5-7 per cent rise for 2008. And especially since his products are somewhat different from those of BHP and Rio, which might - despite successful testing of modest samples by main customers - prompt some pricing questions as the mine cranks up to full production.

China has now, after an initial hiccup, taken over from Japan the role of lead negotiator in the annual iron ore price negotiations. The talks' regular timetable has shifted from a cut-off of April 1, when the Japanese financial year starts, to January 1, for the Chinese financial year.

It would be strange if the major Chinese customers - whose total output rose 18.5 per cent last year, when the country turned into a net steel exporter - were not looking to the arrival of a big new producer as an opportunity to drive the price down.

It would be equally strange if Forrest were not now, as he says, "a happy follower" of the Big Three.

The Indian Government's recent imposition of an export tax costing $8.50 per tonne of iron ore will reinforce the Big Three's dominance and capacity to control price. India supplied 23 per cent of China's imported ore last year.

But as volume catches up with demand in the years ahead, the balance might swing back to the buyers, and Forrest, as the new boy on the producers' block, will come under the greatest pressure.

His commitment to China as virtually his sole international customer could then become a liability, as - motivated by the chance to derail price-setting that some mills resent - they gang up to pick him off. And he would have no Japanese, Taiwanese or South Korean buyers to play off against them in turn.

Forrest, who owns 38.7 per cent of FMG, a stake now worth $3.8 billion, said during the ceremony that Australia's share of China's iron ore market had dwindled from 70 per cent to less than 40 per cent today. "The real problem is the lack of infrastructure in the Australian iron ore industry, and Fortescue's $4 billion investment is aimed to address that."

About 10 per cent of that is being spent on Chinese products, including rolling stock and mining equipment.

And of course, China's demand has soared to such an extent that 40 per cent of today's market comprises much more than 70 per cent of Chinese imports in the 1990s.

More important and telling is likely to be the extent of Chinese investment in FMG itself. Forrest says he has many Chinese investors, and welcomes them. As much as 10 per cent of FMG might ultimately be in Chinese hands already.

When - a more appropriate adverb these days than if - the mine starts operating, will Forrest remain a long-term major shareholder and animating force? There would be many global players itching for effective control of such a strategic asset.

Will he be tempted by one of them, and move on to a new and maybe equally unlikely challenge?

What if ownership ends up in the hands of James Packer, who paid a recent visit - or, perhaps more interestingly, of movers in the main market, China? That would shake the industry up.

Geoff Raby, Australia's ambassador to China, said at last week's signing that the new contract "importantly reflects great confidence in China in the capacity of Australia to be a long-term, stable source of supply - and of course at highly competitive international prices".

Correct. And it would be unwise to under-estimate the desire of China to do in Australia what it's doing in Africa - gaining control of the whole process, or of as much as its massive funds, its long-term outlook, and its state-controlled industry can achieve.

It is establishing by the end of this year a new investment pool with $US200 billion ($243 billion) to spend on overseas activities. The money is already available. Much will change as a result.

But Forrest is already a winner from China's hungry race for resources, maybe the biggest we've seen in Australia. So far.