Growing for the next phase of iron ore

By Paula Wallace

Any indication of rising demand for commodities from the BRIC economies, particularly China, or stock market recoveries are being treated cautiously by analysts.
This was the state-of-play at the recent AJM 12th Annual Global Iron Ore & Steel Forecast conference held in Perth. A cross-section of analysts, looking at every conceivable aspect of the iron ore and steel trades, were unanimous in their apprehension.
Not least, when financiers consider iron ore in terms of credit or equity the current prices of iron ore lump don’t reflect its real value. With benchmark price negotiations still underway the price has not dropped in line with other major commodities but this is expected to happen soon, perhaps coming down by as much as 30 per cent this year.
Chris Fraser, head of metals and mining investment banking for Citigroup, spoke to conference delegates about financing for iron ore projects and where this might be headed in the near to medium term.
“I think it’s fair to say that with this outlook and with…the world moving into a global recession for a certain period of time, 2009 and 2010 are not going to fun years,” he said.
“And I think with a combination of the deteriorating economic outlook and uncertainty, we’re going to see companies moving, more generally, into a capital preservation mode rather than a capital generation mode.”
From a project development standpoint this trend could make it harder for emerging iron ore projects to continue building and accessing capital.
However, Fraser said, “This is the big unknown that I don’t think anyone’s really going to know…until probably the back end of this year at best.”
He said that although the iron ore market has moved into a trough, unlike previous troughs this one is seeing an “unprecedented, co-ordinated global stimulus”.
“We’ve got roughly US$2.5 trillion being thrown at the economies around the world effectively to stave off recession but also…in certain areas definitive spending on infrastructure and hence steel and iron ore intensive industries.”
In terms of the project pipeline Fraser said, “Here we’ve got now, definitive projects that are at various stages of development and we did a rough tally around, and we found about 540 million tonnes of additional supply that could come into the market.”
If you add that to the approximately 62 million tonnes per annum which is already being pulled back from production cuts he said, “you’ve got a pretty scary number in terms of overhang.”
Fraser believes it will take roughly US$50 billion in financing to “unlock this supply” from up-and-coming projects.
“…we’re now going to have a period where not only have we got production cut backs but we’ve still got a lot of people, a lot of jobs, a lot of projects that are wanting to move forward in view of the positive return of things like China and the other BRIC economies in a couple of years,” said Fraser.
“So, we’re going to have an increased level of competition for capital and…we’re going to go back to the scenario of lenders and equity providers wanting to know with certainty…the quality of the products that are going to be produced, are they saleable, who’s going to buy them…etc, etc.”
He said that for the right projects and those who take “the right approach to accessing the right markets at the right time”, capital will still be available.
“The strategic equity which is customers and those sort of sources…that remains there because you’ve got investors taking a long term view of the iron ore industry and wanting to invest for strategic reasons, so that money’s there,” said Fraser.
“What we’ve seen is…it’s a lot harder to get money out of banks now, project finance certainly is tough.”
Looking at the trading performance of the major iron ore stocks between March 2007 and March 2009, it doesn’t look that bad relatively, but when you compare the performance in the last twelve months the picture changes.
“…that’s the taste that’s sitting in the mouth of nearly every investor around the world. So that makes a pretty bleak backdrop in terms of the positive feeling and the positive equity story about what investments people should get behind,” said Fraser.
Strategic equity has been a fairly constant source of capital for the iron ore industry over the years.
“…this remains the most positive source of capital right now because you have investors acting with much more long term investment horizons so you compare this to an institutional raising and this comes with possibility of offtake but also someone taking a view from the other side of the equation with a much more positive angle,” said Fraser.
“The one piece of advice I’ve got is, no matter how good your project is ultimately it’s going to come down to the relationships you’ve formed in China and there are two levels of relationship that people need to form.”
Fraser believes that project developers need to go out and sell their project but they also need to get “some senior air cover”.
“You need to work with people who are able to give you support at particular levels throughout the various systems within China, just to make sure that your proposition, your project gets the appropriate seniority and impetus.”
From a banking standpoint, on a global scale they are constrained having lost roughly US$1.3 trillion dollars in recent months.
“…asset prices have fallen across the world and we’ve got credit exposure sitting in nearly every one of these banks in all forms of asset classes not just sub-prime toxic assets and things like that, that people seem to focus on.
“The reality is nearly every one of the banks around the world is making very tough decisions when it comes to credit so it’s a hard situation to get banks to move right now and to fund things.”
Fraser said that in terms of working out where they sit relative to competitors, iron ore developers will need to rely on the quality of their management teams and the quality of their projects and products.
“It will be an interesting phase over the next few months as we see these markets start to recover and volume start to come back in but we will see the return of material equity and debt into this market. It’s just going to be a matter of time,” said Fraser.


Update: Chinese steel demand recovery expected – Rio Tinto
Rio Tinto said on April 15th that it expected Chinese demand for steel to recover in the second-half of 2009.
Rio CE Tom Albanese added that global iron-ore guidance for 2009 remained 200 million tonnes.
Although well below the level of quarter one 2008, iron-ore production in quarter one 2009 (down by 15 per cent year-on-year) had not fallen below the previous quarter, the asset sales target of $2.5 billion had been met, and Rio’s net debt position had not suffered any significant deterioration.