Unease In Australia

Neville power gazes out the window of a chartered jet at the rust-red, mineral-rich Australian Outback. Power, 53, is the new chief executive officer of Fortescue Metals Group Ltd., a mining company whose one-time penny stock has soared almost 1,500- fold in value in nine years as a result of China’s insatiable hunger for Australian iron ore. While the world teeters on the brink of financial turmoil, Power talks up his company’s next miracle.

Fortescue’s share price surge has lifted the firm into the ranks of the world’s 500 biggest companies—and among the fastest-growing of this century, according to data compiled by Bloomberg. An investment of A$10,000 ($10,318) in Fortescue stock at its lowest point in November 2002 was valued at A$15 million in September. The 31 percent stake of Chairman Andrew Forrest, who took control in 2003, was worth A$5.7 billion.

Power says he’s not resting on past successes. He says Fortescue is spend- ing $8.4 billion to triple production to 155 million tons by 2013. “When we reach that target, we’ll be as big in iron ore as BHP is today,” he says, referring to BHP Billiton Ltd., the world’s largest mining company.

Such lofty ambitions are cutting both ways for Australia, if not for Fortes- cue. The nation of 22.7 million people sprinkled over a land mass the size of the continental U.S. is in the grip of its biggest mining boom since a mid-19th- century gold rush. While delivering record profits for miners, surging de- mand for Australia’s minerals has sent the local currency soaring to its highest level in 30 years. It has also forced the government to keep interest rates at 4.75 percent as of Sept. 12, the highest in the developed world.

The combined impact of an inexorably rising currency and such high borrowing costs has crippled manufacturers, retailers and other nonmining industries. It has also helped to destabilize Prime Minister Julia Gillard’s 18-month-old government, which clung to power by a single parliamentary seat as of September.

Even for miners, the boom carries risks because of the industry’s potentially dangerous overdependence on a single customer. According to Australian government statistics, the country is already the world’s No. 1 exporter of iron ore, coal and alumina. It ranks second in gold, zinc and lead production; fourth in nickel and silver; and sixth in copper. Now, companies such as Rio Tinto Group, BHP and Fortescue are pouring $174 billion into new projects, according to government estimates. Some 40 percent of those minerals are sold to China.

Chinese steelmakers buy more than 95 percent of Fortescue’s iron ore. A recession in the West could slash Chi- na’s growth to 7 percent in 2012 from 10.3 percent in 2010, according to Deutsche Bank AG. Growth may even sink to 5 percent by 2013, Nouriel Rou- bini, chairman of New York–based Roubini Global Economics LLC, told a conference in Shanghai in July. “If China’s growth falls by half, the price of nonfood commodities will be seriously affected,” says Michael Pettis, a finance professor at Beijing’s Peking University.

Gillard rejects such predictions. “We have a resources sector that is turbo- charged by the growth in the region,” she said in an interview with Bloom- berg News on Sept. 15. “There’s no ad- vice to me that would cause me concern about Chinese demand collapsing.”

a slowdown in growth in China, the largest consumer of Australia’s mineral resources, Could hurt the mining industry down under.

That sort of bullishness was on ample display down under in early August when a record 2,400 mining entrepreneurs and their financial backers flew to the Outback. Their destination: the Wild West gold-rush-era town of Kalgoorlie. Their purpose: to party and promote their newest discoveries at a beer-fueled annual convention called the Diggers and Dealers Forum.

This was no Davos, the buttoned- down thinkathon for corporate and political elites in the Swiss Alps. By day, the miners and their bankers convened in a large tent near Australia’s biggest gold mine, a 3-kilometer-long (1.9-mile-long), 1.5-kilometer-wide and 400-meter-deep hole known as the Super Pit. By night, many of them continued their wheeling and dealing at honky-tonk watering holes staffed by female bartenders so scantily clad that they’re known as “skimpies.”

Among those packed 10 deep at the bar amid the fading grandeur of the Palace Hotel one evening in August was David Flanagan, CEO of Atlas Iron Ltd., who has increased his company’s mar- ket value by more than 50-fold to A$2.8 billion during the past five years. “There are so many amazing deposits out there that the opportunities are limitless,” Flanagan, 39, says. Nor is he concerned that Atlas Iron doesn’t have a single customer outside China. “If China suddenly catches the flu, the whole planet’s cactus anyway,” he says.

Gina Rinehart skipped the diggers party but not the dealing. Rinehart, already one of the world’s richest women with a fortune of at least $10 billion, has teamed up with Rio Tinto in the development of the Hope Downs iron ore mine near Fortescue’s pits and is also developing vast coal depos- its in Queensland state on the other side of the country. On Sept. 16, Rine- hart set about making herself another $1.26 billion when she agreed to sell a 79 percent stake in two Queensland coal assets to Indian billionaire G.V. Krishna Reddy’s GVK Power & Infra- structure Ltd.

‘there’s no advice to me that Australia is a powerhouse prodUcer of minerals. would cause me concern about Chinese demand Collapsing,’ Australian prime minister Julia gillard says.

Amid the Diggers and Dealers bonhomie, Todd Buchholz, a former managing director at Tiger Management LLC hedge fund and a one-time adviser to U.S. President George H.W. Bush, struck a note of caution. “China’s golden moment will eventually fade,” he said. “Australia can’t just rely on one narrow part of the world economy.”

Fortescue’s Forrest and Power were the undisputed stars of the convention. Having already made his billions, For- rest passed the CEO baton to Power in

July and stepped up to the chairman- ship so he could spend more time on his philanthropic work. Forrest will be a hard act to follow. Fortescue’s profit for the financial year that ended on June 30 jumped 76 percent to A$1.02 billion as China exceeded the average 10 per- cent growth surge it has maintained for more than three decades.

Lately, China’s red-hot economy has been cooling—even before fears over Eu- rope’s debt crisis deepened and global markets began their plunge in the wake of Standard & Poor’s downgrading the U.S. to an AA+ credit rating. The slow- down began after Beijing raised interest rates and curbed lending in a bid to lower inflation, which in July hit a three-year high of 6.5 percent. Partly as a result, global commodities prices slipped 14 per- cent from April 8 to Sept. 12 after more than doubling in the previous two years, according to the S&P GSCI Spot Index.

The Australian economy is also not shining on miners such as Fortescue. Unemployment, while rising slightly as a result of the troubles of the economy outside of mining, is still just 5.3 per- cent—barely half of what it is in the U.S. While that may sound like good news, there is such a shortage of skilled labor that average wages in the mining indus- try have jumped 33 percent in the past five years to A$2,113 a week. That’s al- most twice as much as miners earn in the U.S., according to government statistics in both countries.

The state of the Australian dollar doesn’t help, either. Mining companies are paid in U.S. dollars by their custom- ers, yet they have to pay their employees in the local currency, which has soared 40 percent in less than three years to well above parity with its U.S. counter- part. It was trading at $1.03 on Sept. 12.

Other costs have spiraled even higher. The giant, 3.5-meter-diameter tires used on dump trucks that haul iron ore and coal have tripled in price to $100,000 each—roughly the price of a Porsche 911 Carrera S—on the spot market, according to Leighton Holdings Ltd., a contractor for BHP and other mining companies. In Au- gust, Rio Tinto blamed rising costs and currency gains for a profit that came in below analysts’ estimates despite climbing 30 percent to $7.6 billion in the first half of 2011.

Now, the mining companies face the prospect of higher taxes. As other sectors of the economy wilt, Prime Minister Gillard is planning to introduce an additional 30 percent tax on iron ore and coal miners’ profits next year and, in a bid to reduce pollution, charge them $23 a ton on their carbon emissions.

Fortescue’s share price has fallen 9.5 percent compared with a 14.9 percent fall in the benchmark index as of Sept. 12. Still, Power says his faith in Fortes- cue’s prospects is undiminished. “All I have to do to allay any concerns is to take another trip back to China,” he says. “It is such a tremendous country, with a great track record of development.”

Power says he’s not reassured simply by China’s soaring city skylines and massive construction projects that consume the steel made from Austra- lian iron ore, coal and manganese. What strikes him more, he says, is the Chinese government’s decision to move major steelworks to the coast from inland. Beijing Shougang Group Co. has already shifted its operations, and Baosteel Group Corp. and Wuhan Iron & Steel Co. plan to follow suit. “That shows the Chinese intend to be- come even more dependent on imported iron ore than on their own domestic mines,” he says.

If something does go wrong in China, Fortescue has a cushion. Power says the company could still be profitable even if iron ore prices plunge to $70 a ton from the average of $169 that For- tescue obtained last year.

Australia’s biggest money manager is also upbeat on China. “People say it’s a bit risky to put all your eggs in the China basket, but China is going to continue to grow,” says Stephen Halmarick, who helps manage A$110 billion at Sydney- based Colonial First State Investments Ltd. “If we don’t sell to China, someone else will.” Halmarick says there’s no sign that the recent global turmoil will slow mining investment in Australia. “There are some massive projects in train in Western Australia, and they will all go ahead,” he says.

Some of Australia’s resources have even bucked the downward commodities trend. On Sept. 6, gold hit what was then an all-time high of $1,923.70 per ounce. Iron ore prices, at $179.50 a ton, were still 28 percent higher on Sept. 12 than a year earlier and may stay at elevated levels until at least 2015 because of short supply and rising demand from China, Edinburgh-based research firm Wood Mackenzie Ltd. said in July. That’s a far cry from the A$28 a ton that iron ore was selling for in November 2002, when shares in a company then known as Allied Mining & Processing Ltd. were trading at the equivalent of just 0.004 Australian cent. Allied owned what turned out to be one highly valuable asset: rights to mine in the Pil- bara, the richest iron ore region in Australia, where BHP and Rio Tinto had been digging ore for 40 years.

In April 2003, Forrest took control of Allied, renamed it Fortescue and began adding adjoining mining leases on flat- land that BHP and Rio Tinto had ignored in favor of the mountains of ore in the nearby Hamersley Range that had appeared more iron rich and accessible.

When the two mining giants refused to let the interloper use their railroad lines, Fortescue raised the money to build its own—one capable of carrying the heaviest loads ever transported by rail. This year, trains 2.7 kilometers long will carry 55 million metric tons of ore across 300 kilometers of sun-scorched wilderness to China-bound ships wait- ing at Port Hedland.

Now, Forrest and his board have en- trusted Power with overseeing Fortes- cue’s next great leap forward: the tripling of production by spending $8.4 billion on the construction of new mines, more heavy-haul rail tracks and a new port. Power says Fortescue will raise half of the funds through regular cash flow and may partly finance the rest by selling shares in Hong Kong or bonds in the U.S.

Surveying what Fortescue has al- ready achieved from 30,000 feet just days before the Diggers confab, Power says that Chinese and other foreign in- vestors, rather than investing in their own mines, should be putting their money into Fortescue shares.

Some already have. In 2009, Chinese steelmaker Hunan Valin Iron & Steel Group Co. paid $1.3 billion for a 17 per- cent stake in Fortescue—an investment

that had almost tripled in value when it sold about 1 percent of its holding in July. Russian billionaire Victor Rash- nikov’s Magnitogorsk Iron & Steel Works bought 5 percent of Fortescue in 2007 for an undisclosed amount. And in 2006, New York–based investment firm Leucadia National Corp. paid $400 mil- lion for a 10 percent stake in Fortescue and a 13-year unsecured note that pays a 4 percent royalty on the revenue from some of its mining operations.

Leucadia has since recouped almost $1 billion in share sales and interest and still retains a 5 percent stake valued at an additional A$921 million. It’s involved in a legal dispute with Fortescue over what it claims is an attempt by the company to dilute its royalties by offering other investors similar notes.

Even so, the New York investors are pleased with the returns Fortescue has delivered. “This is, has and will remain a delicious investment,” Leucadia Chairman Ian Cumming and President Joseph Steinberg said in April in their annual letter to shareholders. How long it will remain so depends not only on Neville Power’s ability to triple production of iron ore but also on China’s appetite for consuming it.

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