Citic Group owns Australia’s largest magnetite mine, producing the kind of higher-grade ores (62% Fe and above), which Chinese steel producers increasingly need to meet the government’s tougher environmental standards. Indeed, the lower quality of China’s own iron ore is one of the main reasons why imports remain on course to hit record highs above one billion tonnes in 2017.
However, in the state-backed group’s half-year report published this month, Citic’s chairman Chang Zhenming said it might suspend its Sino Iron project in Western Australia’s Pilbara region. The mine is miniscule relative to Citic’s overall assets (energy and resources as a whole accounted for just 2% in 2016). And yet as National Business Day reports, Chang devoted almost half his shareholder letter to the group’s difficulties with Sino Iron.
Why was Chang so preoccupied with this one project? As WiC has reported before, Sino Iron has taught China Inc some harsh lessons about the pitfalls of overseas mining investments.
The saga began a decade ago when China started to ramp up efforts to take more control over its commodity supply chain (and hence improve its pricing leverage) by acquiring international assets. In 2006, Citic made a bold move when it paid former Australian MP and businessman Clive Palmer $415 million for land use rights and 100% control of the Sino Iron project.
It was initially projected to cost $1.1 billion to open the mine. Citic anticipated making its first shipments in 2009, building up to an annual output of 84 million tonnes of iron ore and 24 million tonnes of magnetite powder.
However, in a clear demonstration of Citic’s relative inexperience, the first shipment was not made until December 2013 (see WiC163 for Citic’s dispute with fellow state firm MCC over construction delays) and the project costs have continued to spiral upwards ($12 billion plus and counting). National Business Day estimates Citic has made impairment charges of Rmb28 billion ($4.29 billion) over the past three financial years on the mine, which is scheduled to ship just 15 million tonnes of iron ore this year (up from 11 million last year).
The mine’s cash costs are estimated at about $110 per tonne (much higher than a standard mine because magnetite ore needs a lot more processing to get the iron content up to a higher grade). Meanwhile, prices for 62%-Fe Port of Tianjin ore have rebounded to $74 per tonne as of early September, but are still way below their peak of $180 in 2010.
The mine therefore continues to haemorrhage cash. Citic wants to put it on an economic footing by raising output to the originally envisaged capacity. However, it remains embroiled in litigation with Palmer and his company Mineralogy, which Citic’s Chang described as “uncooperative and adversarial” in his recent letter.
Palmer’s trump card is his refusal to sign off documents allowing Sino Iron to expand its storage facilities (needed to expand production) while disputed royalty payments are outstanding. Australian newspapers calculate these at A$150 million ($119 million), with a further A$25 million accruing each quarter.
At issue are “B” royalty payments, calculated against a global benchmark that was suspended in 2010. The “A” payments are based on raw output and are ongoing.
According to court documents, Citic initially argued the “B” payments should be dropped given the benchmark no longer exists. Palmer counter-argued that a new formula could be calculated based on Platts prices and the Baltic Dry Index. Citic recently responded that payments should be “fair and reasonable” based on the “principle of profit sharing, which was both sides’ original intention”.
Chang says Citic may suspend the project – which still represents China’s largest single iron ore mine in Australia – if the legal dispute is not resolved, putting about 2,000 jobs at risk.
So who was Chang’s letter to shareholders really aimed at? Probably not Palmer, who recently told the Australian press that Citic will never mothball a plant it has sunk billions into. Perhaps it is a last ditch plea to the Australian judge whose decision is still pending on the payment dispute.
Chang’s most telling comments concerned “market misconceptions” that the Chinese government is prepared to bankroll unprofitable enterprises. SOEs “don’t have unlimited resources and have to pay attention to making a profit,” he warned.
Either way, the dispute rolls on, with the Australian press reporting the only certainty is a legal appeal by the losing side.
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