Repost: Don't overlook the "IO" in IOCG....
Iron ore - the world's most profitable franchise, redux
Seaborne iron ore is set to maintain is status as simply the most astonishing business of all.
Author: Barry Sergeant
Posted: Thursday , 14 Oct 2010
Back in March 2001, at the start of the commodities supercycle, Pittsburg-based Alcoa was the world's biggest mining name, by market value, at about USD 30bn; BHP Billiton, the world's biggest diversified resources stock, was No 2, then worth about USD 28bn.
Today, Alcoa, with a value of USD 13.7bn, languishes at No 38 among global miners; BHP Billiton is easily at the top, with a gain of nearly USD 200bn in market value, now at USD 218.7bn. This ranks the stock as one of the world's most valuable entities of any kind. Investors who bought Alcoa stock missed the boat, but why?
The divergence in value over nearly a decade may say lots about the apparent pitfalls inherent in Alcoa's focus on a single mineral, even through it is diversified, as such, both upstream (starting with the mining of bauxite), and downstream (fabricating special aluminium alloys); it also speaks volumes about benefits BHP Billiton and its stakeholders have derived from diversification.
The aluminim market has developed specific challenges over the past five years or so. At the specific minerals level, there is little question that the heart of BHP Billiton's success is to be found in its seaborne iron ore division (its high margin petroleum business also does well). The group ranks No 3 globally in seaborne iron ore, after Brazilian supergroup Vale, and Rio Tinto. Given the astonishing profits associated with seaborne iron ore, it is surely no co-incidence that these names rank as the top three miners in the world, by value, with Vale in second position.
Together, the triumvirate hold an aggregate market value of USD 542bn, more than USD 200bn more than the USD 331bn held by Exxon Mobil, the world's most heavily capitalised stock. Of course, the market value of the three miners is not solely attributable to seaborne iron ore, but most of the value is indeed connected to the mineral.
Iron ore is by far the biggest money spinner for Vale; its forays into other areas are yet to yield any convincing successes. Vale went heavily for nickel, of which perhaps the low light was the USD 19bn acquisition of Inco in 2007. Iron ore has ranked at the forefront of Rio Tinto's earnings for some years; its net underlying earnings in 2009 of USD 4.9bn included a contribution of USD 4.1bn from iron ore.
Iron ore (the cement of the modern world) is already a huge market, and set to continue growing at a rapid pace, as developing economies rush to modernise. A recent report by the UNCTAD Trust Fund on Iron Ore Information, in cooperation with the Sweden-based Raw Materials Group, put world production of iron ore at 1.588bn tonnes in 2009. Chinese production figures -- re-evaluated and reduced in the latest study -- came to 234mt (million tonnes), on a "comparable grade" basis, by "upgrading" Chinese grades to the same magnitude as the world average of 63-64%.
China has in recent years fallen to fourth globally in production, after Australia (394mt), Brazil (300mt), and India (257mt). Global recession or not, iron ore trade climbed to a record level of 955mt in 2009, up 7.4% from the previous year. Australia (which houses the main iron ore activities of Rio Tinto and BHP Billiton) ranks as biggest exporter: in 2009 it sent 363mt overseas (a 17% increase); Brazil fell by 3% to 266mt, and India was at 116mt. India's Sesa Goa (part of the Vedanta group) has big growth ambitions; state-controlled NMDC, also an exporter, seems to be crying out for privatisation.
Crucially for miners of seaborne iron ore, China surrendered self-sufficiency (from Chinese iron ore mines) starting around five years ago. China not only uses all of its iron ore, it is also by far the largest importer of the mineral, accounting for two-thirds of world imports. Despite the recession, China's intake of ore climbed by 41% in 2009, to 628mt. Vale, Rio Tinto, and BHP Billiton together controlled 35% of total iron ore production and 61% of total seaborne trade in iron ore in 2009.
Fresh iron ore mining capacity streamed in 2009 was nearly 75mt globally, says the UNCTAD report. More than 685mt of new production capacity may come on stream between 2010 and 2012. Competition is broadening; steelmakers such as ArcelorMittal increasingly invest in "captive" iron ore and also coking (metallurgical) coal operations.
The capital cost of building new iron ore mines is no small beer. In 2007, Vale flagged Serra Sul, a new mine, within its Carajás system in Brazil, as "the largest greenfield site in our history and the largest iron ore project in the world". Project completion was initially slated for the first half of 2012; this has now been pushed forward to the second half of 2013. At least part of the reason is the massive budget required to build Serra Sul: USD 11.3bn (revised up from the original USD 10.1bn). Production at Serra Sul is targeted at 90mt a year implying more than USD 1bn of investment for each 10mt of output.
It seems increasingly likely that even the world's biggest miners could seek partners for new mega iron ore mines. Such a scenario is unfolding around Guinea's Simandou, discovered by Rio Tinto in 2004. Rio Tinto appears to be in a dispute with Vale (and others) over part of the title to Simandou, but for now is pressing ahead.
On 19 March 2010 Rio Tinto announced a non-binding MOU with China's Chinalco, Rio Tinto's largest shareholder, to establish a Simandou joint venture, where the new partner would acquire a 47% interest by providing a USD 1.35bn earn-in over the next two to three years.
The agreement progressed to a binding agreement on 29 July; once Chinalco has paid its USD 1.35bn, the effective interests of Rio Tinto and Chinalco in the Simandou JV will be 50.35% and 44.65%; the remaining 5% will be owned by the International Finance Corporation. While a new government is yet to settle down in Guinea, Rio Tinto appears to be asserting rights to all of Simandou: "Rio Tinto's 95 per cent interest in the Simandou project will be held in the new JV", the group asserts.
Rio Tinto has also indicated the potential size of its Simandou operation. While it may consider an export route through Liberia, the current plan anticipates the construction of a mine at Simandou with annual capacity of 95mt, a 650km dedicated industrial railroad passing through 21km of tunnels traversing Guinea to the coast, a rail car-dumping facility, and a four-berth wharf located 11km offshore from Matakang.
It seems that the overall project, even as currently proposed, could cost well over USD 10bn, given, by comparison, the substantial infrastructure that Serra Sul would be able to access.
For now, it seems that big new iron ore mines can go ahead with confidence. The price of seaborne iron ore is set, as such, at the marginal cost of fulfilling China's demand. Put another way, if the big, low cost, iron ore miners were to produce output surplus to global demand, the pricing of iron ore would be very different. But the Big Three do not produce enough, forcing prices to rise to the point where it is profitable for other, typically smaller and higher cost, producers, to come into the market.
According to the UNCTAD report, Chinese domestic iron ore production has contracted in recent years, and "is likely to fall further as a result of widespread mine closures". The report anticipates that China would likely pay more for the ore it imports, as the new pricing system developing in seaborne markets "gives the major iron ore producers more leverage".
The study describes the international steel industry (the main customer for iron ore) as "fragmented", and maintains that the industry does not act in a coherent manner, thus allowing the three largest iron ore producers "to exercise considerable control" in what now amounts to a "sellers" market. And - for now at least - the world's most profitable franchise.
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