Fortescue Finds a 'China Price' for Iron Ore

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The big winner at this year's iron ore price talks with China certainly was not Rio Tinto -- the Australian-British mining giant that recently saw four employees arrested by Chinese authorities on industrial espionage charges. It was Fortescue Metals Group Ltd., a company that wasn't even at the negotiating table.

Fortescue won a contract on August 17 to sell 20 million tons of iron ore to Chinese steel companies for 94 cents per dry ton for fine ore and US$ 1 per dry ton for lump ore.

In addition, Chinese contract negotiators agreed to help the Australian mining company secure financial backing to help reduce debt and expand output.

Many found the deal surprising in light of the gridlock at ongoing price negotiations between the China Iron and Steel Association (CISA) and Fortescue's largest rivals, Rio Tinto and Australia's BHP Billiton.

"The agreement with Fortescue was, in fact, meant to send a message: China has other options besides Rio Tinto and BHP Billiton," a CISA participant at the talks told Caijing.

CISA said the Fortescue deal set a true "China price." But it's unlikely that other iron ore miners will agree.

Indeed, CISA was disappointed that neither Rio Tinto nor BHP reacted to the "China price" with Fortescue. Instead, each still maintains that Chinese steel companies must accept the same, higher prices being paid by Japanese and Korean counterparts.

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Fortescue CEO Andrew Forrest says his company is a "new force" for the Australian iron ore industry. Since the company was founded in 2003 and launched production in 2008, annual iron ore volume has risen as high as 40 million tons.

It was a big day in May 2008 when Fortescue loaded its first 170,000 tons of ore on a ship at Australia's Hedland port bound for Baosteel's port of Mayishan. Ever since then, the operation has been growing. Forrest expects production to reach 45 million tons by early next year.

But that's a drop in the bucket compared to China's annual imports of about 400 million tons. And China is basically Fortescue's sole customer, buying 95 percent of its ore for 30 iron and steel companies through long-term supply contracts.

Until the second quarter 2009, Fortescue sold 35.1 million tons of iron ore to Chinese companies – a single-digit percentage of total Chinese ore imports. In contrast, Rio Tinto and BHP together are supplying more than 35 percent of China's import needs.

"Fortescue's contracts with China amount to only 10 percent of all long-term contracts with Chinese iron and steel companies, or around 5 percent of total imports," an analyst with Allied Metals told Caijing.

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The numbers underscore China's dependency on Rio Tinto and BHP, the executive vice president at China's Metallurgical Industry Planning Institute, Li Xinchuang, told Caijing.

"Whether in terms of the amount or quality of supply, it is difficult for China to break away from BHP and Rio in terms of iron ore imports," Li said.

China's National Bureau of Statistics says the nation's steelmakers produced 317.3 million tons of crude steel between January and July this year, or about 1.49 million tons per day. Based on this data, this year's crude steel production could reach 546 million tons, up more than 8 percent from 2008, and require 440 million tons of ore, forcing even greater reliance on the giant mining companies.

Ore quality is also an issue. Iron ore from Fortescue's mines is graded at between 59 and 60 percent, below the 61.5 to 63 percent grade dug from Rio Tinto and BHP mines, and the 64 to 67 percent grade produced by global giant Companhia Vale do Rio Doce (Vale) in Brazil.

A marketing executive for Beijing-based Shougang Steel told Caijing that its Caofeidian mill requires relatively high quality and stable supplies of iron ore, which Rio Tinto and BHP provide. "Fortescue products can't fully replace those from other Australian mines," he said.

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Fortescue's Niche

Yet Chinese officials say they don't want to be held hostage by a Rio Tinto-BHP duopoly. Thus, CISA is pinning hopes on Fortescue, which claims to be challenging the major miners.

At the same time, Fortescue urgently needs capital for an expansion program. That's why it made sure a financing clause was written into the agreement with CISA and Baosteel.

In the deal, China agreed to provide between US$ 5.5 billion and US$ 6 billion in financing by September 30. As a result, the mining company is even more tightly tied to China.

Fortescue has tried to open new business in Japan, South Korea and other areas but favors China's rapidly growing market, Fortescue Executive Director Russell Scrimshaw told Caijing. Outside China, he said, ore demand is shrinking.

"The Chinese market is our reason for existence," Scrimshaw said. "Without growth in China, there is no Fortescue. So we're continually looking for an equity relationship with China."

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Forrest told Caijing most of the cash injection would go toward long-term infrastructure for a company expansion.

"Fortescue had been discussing financing with China's banks for 12 months or so," Forrest said. "At this point, this financing is still under discussion with a number of Chinese financial institutions."

Indeed, Forrest was looking for financing when he first came to China in Fortescue's early days. But he refused to cede partial control of the company, and his request was rejected.

Nevertheless, during his initial contacts with China, Forrest succeeded by signing advance-payment supply agreements with Chinese steel companies, helping Fortescue get on its feet.

Today, Forrest has a unique reputation in China. One Chinese steel industry insider told Caijing, "He's a politician running an iron ore business."

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Financial Bumps

The global mining industry hit a wall in the second half 2008, forcing Fortescue to seek help. Soon, the company found itself heavily in debt.

China's Hunan Valin Iron and Steel Group Co. Ltd. came to the rescue in February by agreeing to invest AU$ 1.27 billion in exchange for a 17.4 percent stake in Fortescue. The investment lowered Fortescue's debt-to-asset ratio to 80 percent from 102 percent.

But Fortescue's debt has continued to rise. According to the company's August 10 earnings statement, fiscal year 2009 debt totaled AU$ 3.6 billion, a year-over-year increase of 11.5 percent.

"Actually, Fortescue's financial position has always been bad, equivalent to an A share-listed 'ST company,' " a steel analyst at a Chinese brokerage told Caijing.

The relatively young Australian miner also needs to catch up with the big boys. Analysts say unless Fortescue increases annual production capacity to 120 million tons, it will be unable to compete with Rio Tinto and BHP, whose production costs are now significantly lower due to economies of scale.

To accomplish its goal, Fortescue needs at least another US$ 3 billion to restructure debt and expand capacity. And that's exactly what it hopes to accomplish through the agreement signed with CISA and Baosteel.

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China Price

On the Chinese side, CISA also hopes to take advantage of the deal with Fortsecue by improving China's price position.

China currently buys iron ore in two ways: through contracts, and on the spot market. Spot prices usually far exceed long-term contract prices, peaking last year at more than US$ 60 per ton above contract prices.

In the latest agreement, prices for Fortescue ore apply to all its exports to China, whether sold through contract or on the spot market.

Shan Shanghua of CISA says a key concern for China is to align long-term contract and spot market prices.

"Aligning the spot price and contract price to form a unified ‘China price' is the only way to prevent the speculative hoarding that results from having two prices for the same commodity," Shan explained.

But unified pricing is not assured. One reason is that some Chinese steel companies would rather import ore bought on contract and then resell it for more money on the spot market, pocketing the difference.

Xu Xiangchun, head of the Beijing Steel Association Information, thinks unifying prices will be difficult to achieve.

"Chinese steel enterprises can profit from reselling their contract ore," Xu said. "Why would contract ore suppliers -- the three major mining companies -- want to cancel spot market sales?"

Fortescue's sales are entirely contract-based because its ore supply is small, Xu explained. "Perhaps only Fortescue would accept a unified price," he said.

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And in the current environment, Rio Tinto and BHP are both doing their best to sell ore on the spot market. A July 29 report from BHP showed customers who buy 30 percent of the company's ore pay according to "mixed annual pricing," which includes quarterly pricing, spot pricing and index pricing.

That Fortescue's agreement failed to garner support from Rio Tinto and BHP has raised questions about next year's price negotiations. But an improving economic situation and bullish steel pricing have reversed negative expectations about 2010 pricing.

An August 18 research report by U.S. financial firm Citigroup projected ore prices to rise 15 percent next year, modifying previous expectations of a 16 percent decline. The report said even with ore producers operating at maximum output, ore demand will exceed supply for the next two years.

And much of that demand will be based in China. Clearly, despite recent success with Fortescue and a "China price," more challenges lie ahead for China's ore-hungry steel producers.

snoopie

来个中英文对照吧^_^有助加强理解.