Mining the riches of OZ

Andrew “Twiggy” Forrest isn’t the most likely candidate to become the poster boy for Australia’s mining boom. His last big venture ended in disaster for many investors. U.S. bondholders who bet US$400 million on an Australian nickel mining company he founded in the 1990s, Anaconda Nickel Ltd., recouped only 26 cents on the dollar. Anglo American Plc, the world’s second-biggest mining company, fared even worse. It walked away with just 7 percent of its US$200 million investment in Forrest’s company.

Today, Forrest, 46, has once again charmed investors, in Australia and beyond, this time with the promise that he’ll become one of the largest suppliers of iron ore to China. Leucadia National Corp., a New York–based holding company with interests ranging from wine to real estate, invested US$400 million for a 9.92 percent stake in his publicly traded Fortescue Metals Group Ltd. Russian steel billionaire Victor Rashnikov owns a 5.3 percent slice and plans to raise it above 15 percent.

Birmingham, Alabama–based Harbert Management Corp. already owns 15.6 per- cent. Fortescue shares were the best per- formers in Australia’s benchmark index in 2007 as of Dec. 12, rising more than four- fold. On Dec. 19, the company enacted a 10-for-1 share split. Forrest’s 36 percent stake in the company was worth 6.1 billion Australian dollars (US$5.4 billion).

So far, Fortescue hasn’t produced a single ounce of iron ore.

“There’s a feeding frenzy going on over Australian resources,” says David Parker, 42, director of the Chamber of Minerals and Energy in the state of Western Australia. The country’s economy has been soaring along with the global commodities boom. Emerging giants, led by China, are bat- tling one another for a share of Australia’s natural resources to fuel their continuing economic expansion. Australia is the world’s No. 1 exporter of iron ore, coal and alumina, which is derived from bauxite. It ranks second in zinc and lead; third in gold, nickel and manganese; fourth in copper; and fifth in liquefied natural gas (LNG), according to the Australian Bureau of Agricultural and Resource Economics, a government agency. It also has the world’s biggest known uranium reserves and is the No. 1 producer of diamonds by volume.

Australia may be riding a commodities supercycle in which prices will rise for decades, says Alan Heap, Sydney-based director of commodities analysis at Citi- group Inc. Per-capita steel consumption in China, with 1.3 billion people, is less than half that of other developing countries. That means it could take decades for the country’s commodities demand to slacken, he says. Iron ore prices have tripled in the past five years. Gas prices are rising too. In September, PetroChina Co., the world’s biggest oil company, said it would buy as much as US$60 billion of Australian LNG at prices estimated to be three times those China’s Cnooc Ltd. agreed to pay in 2002.

Previous predictions of a supercycle haven’t always proven correct. Australian resources fueled Japan’s industrialization in the 1960s and ’70s. Amid the euphoria, stocks such as Poseidon Nickel Ltd. soared to A$280 in February 1970 before plunging to A$39 the same year, when the company turned out to have less nickel than anticipated. “It was a manic phase,” says Hans Kunnen, 53, who helps manage the equivalent of US$117 billion in equi- ties at Sydney-based Colonial First State Global Asset Management, recalling that earlier boom. “This time, the question is, Is it a supercycle or just another cycle that will end in tears?”

Some Australians are already suffering. Inflation hit 3.1 percent in 2007—above the Reserve Bank of Australia’s mandated ceiling of 3 percent. The benchmark interest rate, meanwhile, has jumped to 6.75 percent in December from 5.25 percent in the first quarter of 2005, boosting the cost of home mortgages. The average Australian family has to spend 36.6 percent of its income to keep a roof over its head, behind only New Zealand and the Nether- lands among members of the Organization for Economic Cooperation and Development. The rise in interest rates was one reason voters dumped the country’s prime minister of 11 years, John Howard, 68, in a Nov. 24 general election and chose Labor Party leader Kevin Rudd instead. Rudd, 50, a former diplomat who speaks fluent Chinese, portrayed himself as better equipped to keep inflation and interest rates under control.

China, already Australia’s No. 1 minerals customer, has become its fourth-largest foreign investor as well, with A$42 billion of projects. Chinese companies have also expressed interest in buying Australian mining firms. On Dec. 7, Sinosteel Corp., China’s second-biggest iron ore trader, launched a A$1.2 billion bid for Perth-based Midwest Corp., trumping an earlier bid by Murchison Metals Ltd., a company backed by Japanese and Korean rivals. If successful, it would be the biggest overseas metals acquisition by a Chinese company.

That makes some Australians wary. “If an Australian company tried to become involved in a key aspect of the Chinese economy, the Chinese would block it,” says Barnaby Joyce, a senator who’s a member of the National Party, which governed with Howard’s Liberals until November. Joyce says he’ll demand that the country’s Foreign Investment Review Board intervene if Chinese government–linked companies try to acquire

Australian assets. In 2001, the country blocked a bid by The Hague–based energy concern Royal Dutch Shell Plc to take over Woodside Petroleum Ltd., Australia’s biggest oil and gas company, citing national interest. The Chinese pay as much as US$50 a metric ton less in shipping costs for iron ore they buy from Australia because of its relative proximity com- pared with, say, Brazil, according to the Baltic Exchange Ltd. “Australia’s a hot spot—everyone wants to grab a deal,” says Moya Zhang, Chinese-born managing director of Reachco Ltd., a Sydney-based consulting firm that advises Chinese companies. “Unlike resource-rich countries in places like Africa, Australia is also politically very stable and has a good investment environment.”

The boom has been good for Australian investors and the economy. The benchmark S&P/ASX 200 Index more than doubled in the four years ended on Dec. 12 to 6,615 from 3,212 compared with a 38 percent rise in the Standard & Poor’s 500 Index. Australia now has the world’s fourth-largest fund management industry, with A$1 trillion of assets. Gross domestic product grew 4.3 percent in the third quarter of 2007 compared with 2.6 percent a year earlier. Unemployment was at a 22-year low of 4.5 percent in November, according to the Australian Burean of Statistic. The Australian dollar, once derided as "the Pacific peso", almost doubled in value in six years, reaching a high of 93.6 cents against the U.S. dollar on Nov. 7 compared with a low of 48 cents in September 2001.

‘the question is, is it a supercycle or just another cycle that will end in tears?’ Fund manager hans kunnen says.

There could be too much of a good thing. Bottlenecks in overcrowded ports and rail lines have sent costs of Australian minerals and energy soaring. The price of power station coal exported from the world’s largest thermal coal port, New- castle, 100 miles (160 kilometers) north of Sydney, almost doubled to US$89.76 in the week ended on Dec. 7 from US$49.52 a year earlier, according to the weekly GlobalCOAL Index. Rising prices could make shipping from Africa or Brazil comparatively more attractive, Citigroup’s Heap says, adding that the cost of mining iron ore in the Pilbara region of Western Australia has doubled.

Melbourne-based BHP Billiton Ltd., the largest mining company in the world, cited potential cost savings as one of the reasons for its US$127 billion proposal to take over London-based competitor Rio Tinto Group. If the deal, which Rio is opposing, goes through, it would create the world’s third-biggest company, after PetroChina and Exxon Mobil Corp., with a market value of US$394 billion, bigger than GE Co. BHP Chief Executive Officer Marius Kloppers is lobbying Rio shareholders. “We are very patient people,” Kloppers, 45, said at the company’s annual meeting in Adelaide, Australia, on Nov. 28.

The potential economies of scale are most evident in the Pilbara, a 500,000-square-kilometer (190,000-square-mile)

region of northwestern Australia that holds most of Australia’s iron ore and natural gas deposits, and where the two companies have iron mines. The competing mines sit side by side in some places on the sun-scoured, rust-red landscape, so close together that miners can hear blasting from the rival camps. “They call it the Iron Curtain,” says Parker of the Chamber of Minerals and Energy, gesturing out the window of an 18-seat air- craft as it makes a shuddering descent. “It’s the dividing line between two great corporate empires.”

Once the iron ore is dug out of open- cut pits up to 3 kilometers wide, it’s load- ed onto separate 2.5-kilometer-long trains and freighted 300 kilometers to the coast. BHP and Rio Tinto have separate railroads and ports that Kloppers says could be consolidated. “Our customers will see more product, more quickly, at a lower cost,” Kloppers said at the company’s annual meeting. “These two companies are worth more put together than they are apart.” Rio hasn’t ruled out accepting a higher bid.

What BHP and Rio Tinto do agree on is that the industrialization of China will offer them growth opportunities for decades. BHP’s move on Rio is just one of a score of deals being proposed and struck around the outback. Billionaires from Australia, Russia, Ukraine and the U.S.; international fund managers; and Chinese, Indian, Japanese and Korean conglomerates are attempting to buy stakes, form joint ventures or win control of Australian mining companies.

The rush for resources has driven up mining stocks. In 2007 as of Dec. 12, BHP rose 71 percent to A$43.20 and Rio Tinto doubled in London to 5,658 pence. An index of nine small and medium-sized iron ore stocks tracked by Commonwealth Securities, the brokerage arm of Common- wealth Bank of Australia, soared 1,500 per- cent from January 2003 to November 2007. “Even the technology boom of the late 1990s pales in comparison with the recent performance of the Australian iron ore sec- tor,” says Craig James, 45, Common- wealth’s chief economist. “And the tech boom was only built on ideas and concepts. With iron ore, it’s been something much more concrete: demand from China.”

Chinese companies are pouring money into deals to lock in supplies of natural resources. In September, Chinese President Hu Jintao witnessed the signing of a A$1.8 billion iron ore joint venture between Anshan Iron & Steel Group, the country’s third-biggest steel company, and Gindalbie Metals Ltd. to develop two iron ore projects in Western Australia. In December, Citic Pacific Ltd., the Hong Kong arm of China’s biggest state-owned investing company, said it would spend A$5.2 billion in the Pilbara region to export 27.6 million tons of iron pellets and concentrates annually for at least 25 years. Aluminum Corp. of China, the country’s biggest producer of the lightweight metal, in May won approval from local Aboriginal landowners to develop a A$3 billion bauxite mine and refinery at Aurukun, a remote community on Cape York, the northeastern tip of Australia that points toward Papua New Guinea.

“China is no longer interested in just being a buyer,” says John Saunders, chair- man of Yilgarn Infrastructure Ltd., which has joined with five Chinese companies to bid for contracts to build a rail line and port worth A$3 billion to ship iron ore out of Australia. “They want to control the means of production and the transportation infrastructure.” Chinese steelmakers and the government are even studying a joint bid for Rio Tinto to counter BHP’s offer, Chen Hanyu, a director at the resource office of Beijing-based Shougang Crop., the nation's ninth-largest steelmaker, said in December

Fortescue Metals’ Forrest is well aware of China’s financial might. Fortescue counts 10 Chinese steelmakers, including its biggest, Baosteel Group Corp., among its future customers. In addition, Fortescue teamed up with Baosteel to jointly develop a mine in the Pilbara.

Near the BHP and Rio Tinto iron sites in the Pilbara, Fortescue has secured 40,000 square kilometers of mining leases and is completing a mine, railway and port at a cost of A$2.7 billion. Forrest, the descendant of a pioneering Western Australian family that included the state’s first premier, says the concession will be able to produce and export 45 million tons a year to start with, rising eventually to 200 million tons—more than either BHP or Rio currently produce in the area. “It’s the world’s richest, most-under- explored mineral region,” Forrest said at a mining conference called the Diggers and Dealers in the outback gold mining city of Kalgoorlie in August. He declined to be interviewed for this article.

In Perth, the Western Australian state capital, where Forrest and other Fortescue executives work in an open-plan office, a countdown clock ticks off the days, hours and minutes to May 15, when Forrest has promised shareholders and customers such as Baosteel that the first ore will be loaded. Once it does, Leucadia will start to receive 4 percent of the company’s revenue from two of its mines for the next 13 years.

The Chinese face lots of competition for Australia’s mining assets, as Sinosteel’s bid for Midwest shows. Rival bidder Murchison Metals is backed by Japan’s Mit- subishi Corp. and South Korea’s Posco. Both Murchison and Midwest, which already has a joint venture with Sinosteel, are mining iron ore in the desert as far as 400 kilometers from the sea. Whoever wins the day will gain control of a planned rail line and port via which iron ore can be shipped to China. “You can have the best mine in the world, but without a railway and port, you have nothing,” says Paul Kopejtka, Murchison’s chairman.

Russia and india are also grabbing for Australia’s resources. In September, President Vladimir Putin visited Australia and struck a deal with then Prime Minister Howard to buy uranium. The Russian deal is due to be completed in 2008. Australia in 2007 also agreed to sell uranium to China and India. Rudd’s new government also supports uranium exports. In 2007, his Labor Party scrapped its policy of opposing new uranium mines.

Australian miners are having trouble producing commodities fast enough to meet global demand. Transportation snafus mean Australia risks losing as much as A$7.9 billion in export revenue in the next decade if port and rail congestion can’t be resolved, the Bureau of Agricultural and Resource Economics forecast in 2007.

Sunbathers on the golden beaches north of Sydney who once saw the occasional passing ship can now view an armada of bulk carriers that have to queue for as long as a month to enter the port of New- castle. Coal is Australia’s most valuable export, bringing in A$23 billion in the financial year ended on June 30. On July 2, a record 79 ships were waiting in line to enter the port. BHP, Rio and Xstrata Plc are among the exporters affected.

Components for mining equipment are in such short supply that tires for dump trucks and earth- movers, measuring up to 3 meters (10 feet) in diameter and normally selling for A$20,000 each, are fetching up to A$100,000 on the spot market. And a skills shortage means recruitment agencies are scour- ing the world to find mining professionals. “There’s a dramatic need to create a labor pool,” says Jim Stitt, 60, managing director of Perth-based OSS International Recruitment, who says he’s currently searching for 1,600 mining professionals ranging from geologists to diesel mechanics—up from 400 in 2005—to fill the void

Tracey Eckerman, 34, quit her job as a community relations officer five years ago to drive 230-ton Komatsu dump trucks inside Rio Tinto’s 250-meter-deep West Angelas mine in the Pilbara. She says she can earn as much as A$110,000 a year, almost three times what her friends work- ing in administration make back in Perth.

Mines working at full capacity, maintenance downtime and staffing shortages are increasing prices. In December, Australian and Brazilian iron ore producers were still negotiating annual contract prices with Chinese and Japanese steel companies.

Meanwhile, in a single week in December, the price of iron ore arriving at Chi- na’s port of Beilun rose 4.2 percent to 1,500 yuan (US$203) a metric ton. That was four times the contract price, which doesn’t include ship- ping and insurance. BHP’s Asian and European customers fear its bid to take over Rio Tinto will give the world’s biggest miner even more power to dictate prices. BHP and Rio’s combined share of the market for iron ore would be 40 per- cent—the same share the Organization of Petroleum Exporting Countries has in the oil market. In November, the Brussels- based International Iron and Steel Institute, whose members include 19 of the world’s 20 biggest steelmakers, along with the China Iron and Steel Association, issued statements opposing the BHP deal.

Some of Australia’s biggest fund managers remain optimistic that the resource boom will go on indefinitely despite the difficulties of getting goods to market and the pressures of inflation. “We’re looking at a massive amount of demand,” says Shane Oliver, 47, who helps manage the equivalent of US$100 billion at AMP Capital Investors, a unit of Australia’s biggest life insurer, and is overweight on resources stocks. “We are still not at the point where valuations are excessive.”

Forrest likely would agree. Fortescue’s shares are soaring, and the company has yet to woo the big Australian investment funds. “They’re all underweight on us,” says Exec- utive Director of Operations Graeme Row- ley, a former Royal Australian Air Force pilot and Vietnam veteran. Rowley, 67, retired from a job at Rio in 2003 and bought shares in Fortescue for 8 Australian cents apiece when he joined it that same year. The stock was trading at A$60.96 on Dec. 12.

The wariness about Forrest is evapo- rating, says Paul Xiradis, who helps man- age A$7 billion at Ausbil Dexia Ltd. in Sydney, including Fortescue shares. “There has been a lot of skepticism about what he could achieve, but he’s learned from the past,” Xiradis says. Whether investors’ faith in Forrest pays off depends on whether this Australian com- modities explosion turns into the fabled supercycle or the frenzy fades.

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