Energy & Resources

Digging for victory

China seeks greater control over Australian iron ore reserves

A labourer walks past the gate of the headquarters of Baosteel Group Corp. in Shanghai

Now with big ambitions in the Pilbara: Baosteel

In 1886 a young Englishman called Harry Page Woodward spent a year crossing 13,000km of Western Australia on a camel. As the state’s new geologist, Woodward’s job was to map a region he came to describe as ‘iron country’. What Page had discovered was the iron ore potential of the Pilbara. He believed there was enough ore “to supply the whole world”.

He was right. Today, iron ore extracted from the Pilbara not only constitutes the majority of the 610 million tonnes that Australia is likely to ship in 2013 and 2014, but also the major chunk of the 850 million tonnes China will import this year, according to blog The Conversation.

China was the destination for 72% of the world’s iron ore in 2013. But rather than just import the stuff, Beijing wants to own the ores that supply its massive steel industry. State-owned Baosteel seems to have heeded that policy diktat this month, launching a $1.3 billion unsolicited, all cash bid for Aquila Resources in association with Australian commodity rail freight operator, Aurizon Holdings.

China’s largest steel producer already owns 19.8% of the listed Pilbara-based group, which it purchased in 2009. But Baosteel’s chief financial officer, Wu Yiming, told reporters it launched its A$3.40 per share bid after getting fed up with progress on Aquila’s stalled A$6.93 billion ($6.49 billion) West Pilbara ore project. This has effectively been on hold since 2012 after Acquila’s 50% joint venture partner AMCI baulked at the cost of the capital expenditure plan. AMCI is itself a joint venture between US commodity specialist AMCI International and South Korean steel giant, Posco.

For Baosteel, increasing its investment in Aquila will move it closer to becoming a more vertically integrated player, as well as reducing its reliance on the world’s largest iron ore producers Rio Tinto, BHP Billiton and Vale.

China’s steel firms have tried to crack the existing oligopoly for years but their efforts have been stymied by a lack of control over a fragmented domestic industry in which demand from small-scale producers often drives up prices on the spot market. The race to secure supply during the peak of the steelmaking splurge four years ago, pushed benchmark iron ore contracts to record highs of $180 per metric tonne.

Prices are down from those heady levels. This year they have dropped 24% to $102.70 (as of last Friday) under the twin pressures of reduced Chinese demand and ramped up supply from the three majors (Vale is expected to produce 360 million tonnes per annum this year, followed by Rio Tinto on 300 million mtpa and BHP Billiton 217 mtpa).

In that context, some industry experts are questioning why Aquila is pushing to bring its two billion-tonne project on stream. Could it be a negotiating tactic to reduce prices, for instance? Or as The Australian newspaper concludes: “Now Baosteel has declared its hand – either you guys help drive iron ore prices lower by taking up all your exploration options, or we’ll ensure an oversupply situation for the long-haul.”

Others are applauding Baosteel for its timing. The company has pitched its bid at a 52.7% premium to Aquila’s 12-month trading average. But Aquila’s share price is currently in the doldrums and its management will not be happy with the proposed valuation. This is primarily why Baosteel bypassed them and went directly to shareholders, although getting a 50% acceptance rate may hinge on the views of executive chairman Tony Poli, who owns 29%, and his co-founder Charles Bass, who owns 11%.

Analysts say the two men may have to accept the offer because of the ongoing difficulties in funding the West Pilbara project’s capex. This is the primary source of disagreements with its joint venture partners, who look likely to support Baosteel’s bid themselves. By contrast, Baosteel can draw on the immense financial firepower of China Development Bank. In 2012 the two signed a strategic co-operation agreement, granting Baosteel $20 billion of capital for global projects.

Should the bid succeed, Baosteel will own 85% of Aquila and Aurizon 15%. The two plan to split the railway project and processing port from the mine, which will reduce Aquila’s share of the total outlay. About $4.3 billion of the project’s current costs involve the construction of a 430km railway line and 350 mtpa processing port at Anketell, which will also serve independent producers unable to transport stranded reserves out of the Western Pilbara.

Will the bid succeed? Analysts aren’t expecting a competing offer. They also believe that the bid will be passed by Australia’s Foreign Investment Review Board (FIRB) as a domestic firm is involved in the consortium. What may yet transpire is a personal sweetener from Baosteel to convince Tony Poli to give up the company he founded 14 years ago.

The three iron ore majors are talking down the deal’s potential significance. Last week, the Sydney Morning Herald quoted Rio Tinto CEO Sam Walsh as saying the lead-time between finding a resource and starting operations has blown out from 10 to 27 years.

Nor has China’s track record in Australian mining investment been a happy one. As we have reported before (see WiC 220), Citic Pacific’s Sino Iron Pilbara venture with Metallurgical Corp of China has ended up in litigation after massive overruns and delays, which pushed up the costs from $2.5 billion to nearly $10 billion.

Nonetheless, Baosteel and Aurizon say they are confident about their prospects in the West Pilbara project, which underwent a detailed feasibility study in 2012. Aurizon chief executive Lance Hockridge says it could start producing iron ore in 2017 and that the resource has been graded at an average of 57.1% iron content, which meets the quality standard for DSO (Direct Shipping Ore). If the deal comes off it will eventually reduce Baosteel’s reliance on the three majors. On completion of the project’s first stage the mine ought to be shipping around 30 million tonnes per annum to Baosteel’s foundries.

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