August 2010

Essays

Paul Barry

China’s quarry

A hillside spotted with iron deposits at Atlas Iron's Wodgina project site, south of Port Hedland in the Pilbara region. © Carla Gottgens/Bloomberg via Getty Images

It’s a beautiful sunny day in the middle of winter and we’re looking down on a wide, scrubby plain that stretches some 200 kilometres west across the wheat belt to Geraldton, on the western Australian coast. In front of us runs a cavalcade of colours: white clouds; blue sky; grey–green bush; red earth; green, blue and yellow Port Lincoln parrots; and rusty red and black rock. It’s rusty because the Karara Ridge we’re standing on is a massive lump of iron ore worth $100 billion at current market prices; it is about to be dug up, shipped off to China and turned into steel.

Eighty metres below our vantage point is a flat oblong the size of 15 footy fields. Deep red in colour – because the vegetation has been stripped away – it is speckled with giant yellow earthmovers that look like beetles and a couple of hundred tiny figures dressed in bright orange vests and white hard hats. This small army of construction workers is busy building a nine-storey crushing plant, which will spit out its first shipload of fine magnetite iron ore in September 2011. Soon after that, some of the black sand-like granules, which contain 68% iron, will return to Australia as body panels in brand new BMW and Audi cars.

The Karara iron ore project in Western Australia’s mid-west region is a $2 billion joint venture between a little-known Australian mining company, Gindalbie Metals, and China’s third-largest steel maker, Ansteel; the latter company has kicked in $700 million in equity and will take everything the giant open-cut pit produces over the next 30 years. The rest of the project funding is coming from the China Development Bank, which will lend US$1.2 billion to build the mine, bring in new powerlines and lay a rail link to Geraldton, where money is also going to be spent on a huge new loader for the ageing port.

Not far from where we’re standing, they’re already building a village, complete with gym, cricket pitch and swimming pool, that will house 500 mineworkers in rooms with ensuite bathrooms, flat-screen TVs and broadband internet. “There’s no way this would be happening without the Chinese,” Gindalbie’s managing director, Garret Dixon, assures me as we gaze down on the activity below. “There’s no other way we could have got the finance. No one else in the world would have put up the money.”


Dixon had flown up to Karara on a company charter flight from Perth that morning, having jetted in from Canberra late the night before. Twenty-four hours before our meeting he had been standing in Parliament House next to the Chinese vice-president, Xi Jinping, and Kevin Rudd (in one of his last acts as prime minister) for the ceremonial signing of Gindalbie’s US$1.2 billion loan agreement. He was first in the queue, ahead of Andrew ‘Twiggy’ Forrest and eight other Australian businessmen, who were signing Chinese deals worth $10.5 billion. “Twiggy hated the fact that he had to wait,” Dixon says with a chuckle.

Gindalbie was deservedly first cab off the rank, because it’s a perfect example of how Chinese investment in Australian resources can work to mutual advantage. The deal will guarantee China’s steel mills security of supply for the next 30 years, while generating for Australia 500 long-term jobs, up to $3 billion per year in export revenue, up to $150 million per year in mining royalties and a big whack of taxes that this country would otherwise be denied.

The geologist who “discovered” the Karara deposit is the former head of exploration at Gindalbie, David Flanagan. Half-Irish and half-Polish, he is energetic, funny and strangely innocent – hardly a stereotypical miner. His pale, freckly skin and red–blond hair are wildly unsuited to the harsh outback sun. Back in 2003, Gindalbie knew nothing of the riches buried on their property until their next-door neighbour, Mt Gibson Iron, offered $1 million for the mining rights. Flanagan went to consult the maps at the Western Australian Department of Mines and was astounded to find that the ridge was known to contain 2 billion tonnes of magnetite. “The price of iron ore was really low back then, so I wasn’t that excited. If they’d been prepared to pay us $4 million I’d probably have said ‘yes’.” But Mt Gibson didn’t raise their bid and the rest is history.

Flanagan now runs another mining company, Atlas Iron, which he started in 2004 after reading Paulo Coelho’s The Alchemist, whose young shepherd hero abandons his flock to find treasure. Six years later, this business, which he began with a $4.5 million share issue, is worth more than $1 billion but, unlike Twiggy Forrest or Clive Palmer who have become self-made billionaires from mining, Flanagan has made very little for himself. Thinking this would be just a rehearsal for the real thing, he didn’t pay much attention.

Atlas Iron currently makes its money from a number of small open-cut mines in the Pilbara, a landscape that looks like an Albert Namatjira painting: pale green saltbush, dark red soil, outcrops of rock on the steep-sided hills and brilliant-white bark on the few straggly gums. Next to its small pits the company owns a huge ore deposit, known as Ridley Ridge, which contains 2 billion tonnes of magnetite, like Karara. Atlas would need to spend $2.7 billion to develop this into a mine and to build a 25-kilometre slurry pipeline to carry the ore straight out to bulk carriers, thus bypassing Port Hedland, where BHP and Fortescue Metals have a stranglehold. So it, too, needs a rich partner. “No one has offered enough to clinch the deal yet, but we’re expecting to have an agreement by Christmas,” says Flanagan, who has just knocked back an offer of $230 million for a 70% stake in the deposit. “We’re not going to give it away just to raise a bit of money,” he says.

A high-level Chinese delegation is looking round the Pilbara mine the day I visit, and Flanagan is determined to keep us apart. He tells a hilarious story about teasing a previous posse of Chinese investors with tales of terrible snakes, crocodiles and killer bees. You hope he’s treating his more serious suitors – who include one Japanese, one Chinese and one Saudi–Indian consortium – with greater care.

Australian investors and banks don’t like projects such as Ridley or Karara, because there’s too much money and risk involved, and no security if all goes wrong. Half-built mines aren’t worth a cracker to creditors or shareholders; nor are mines whose production cost exceeds the iron ore price, which will almost certainly happen in the next 30 years as demand for minerals slows down. Back in 2004 the iron ore price was below US$40 per tonne, which is roughly what it will cost Karara and Ridley, before royalties, to get the ore onto the boat.

Magnetite mines gobble up massive amounts of capital for two reasons. One is the logistics of getting the ore to the ship from way out in the bush. The other is that magnetite costs far more to process than the hematite BHP and Rio Tinto mine in the Pilbara, which can be dug out of the ground and thrown in the hold. Magnetite has more impurities than this so-called “direct shipping ore”, so those who mine it need to build huge processing plants to crush the ore and bash it into fine particles, which are then separated from the waste with giant magnets. The extra cost of building such a plant is around $1 billion, which constitutes a huge risk because the money needs to be spent upfront. If ore prices collapse, you can’t just shut up shop and reopen when prices recover. You lose your dough – lots of it. Consequently, Gindalbie and Atlas Iron are not the only ones seeking Chinese capital. There are at least half-a-dozen big magnetite projects in Australia that would not have gone ahead without a foreign partner. Several of these are in the mid-west region and belong to the Geraldton Iron Ore Alliance, which was formed to lobby the Western Australian government for a new port and rail link. Four of the alliance’s five members are either wholly Chinese-owned or have a Chinese partner.

But it’s not just Geraldton and not just magnetite. According to the Foreign Investment Review Board (FIRB), China invested $26 billion in Australian mining companies and projects in 2008–09, which was almost one-third of all foreign investment in the sector. And plenty more is on the way. The latest figures show that 170–180 deals with Chinese businesses have been approved since Labor took office in November 2007, with 60–70 having been processed this year alone. So far, none have been turned down, despite Australia having one of the most restrictive foreign investment regimes in the world. A few have been modified or had conditions attached, but the rest have gone through untouched.

This tidal wave of Chinese money came right out of the blue: there were more applications in the first six months of the Labor government than there had been in 11 years under Howard, and Chinese investment each year is now running at seven times the total for the decade up to 2006.

It’s no coincidence that the flood began with the global financial crisis, when the capitalist world fell into a deep hole and the doomsayers held sway. As the price of mining shares collapsed and the Australian dollar fell through the floor, the Chinese government urged its steel makers to grab Australian resources as fast as they could. One senior Chinese official told a Beijing mining conference in 2008 that it was not just a good idea but their “national duty” to do this.

Also, since no one else was in the market buying, the Chinese had no competition. According to David Olsson, Beijing partner of the Australian law firm Mallesons Stephen Jaques, which advised Hunan Valin Iron & Steel on its purchase of a stake in Fortescue Metals last year: “They saw the opportunity to use their vast capital resources to buy up assets. The GFC excluded Australian mining companies from other capital markets, so China stepped in to allow them to stay in business or continue to expand.”

“The Chinese are masters of this,” says Tim Schroeders, who manages billions of dollars for Pengana Capital in Melbourne, “but they have a different mindset [from most Western investors]. They’re prepared to look at a 20- to 30-year timeline, while investors in Australia can’t see beyond today’s close of trading on the stock market.” Certainly, China has the money to buy anything it wants, because the country has the world’s largest foreign exchange reserves and desperately needs to put them somewhere other than American Treasury bills, whose value declines whenever the US dollar falls. And China realises it may never have a better opportunity. A few months ago a report to the ruling state council warned that it was “a race against time” to buy more assets while prices are low.

Many Australians worry about this. A survey of 2000 investors published in Fairfax’s Business Day in January 2010 (in the midst of the Stern Hu affair) found only one person in five thought Chinese investment in Australia fine and dandy. The rest were concerned about China’s human-rights record, feared that its state-owned companies might not act in Australia’s national interest or believed that we shouldn’t let foreign companies buy up this country. Other surveys by the Lowy Institute have reported similar anxiety and opposition.

But it’s too late to worry about selling off the farm, because that process is almost complete. Virtually every petroleum or gas project in Australia is either foreign-owned or has a foreign partner. The same is true of just about every new coalmine and every new iron ore mine. And it’s not just the Chinese whose money we’re taking. If you poke around the major new minerals and energy projects listed by the Australian Bureau of Agricultural and Resource Economics (ABARE) you don’t have to dig far to find a foreign flag. You hit paydirt fastest in petrol and gas, where 33 of 36 major projects under development in Australia have foreign partners. Most of these are multinational oil companies, such as Chevron, BP, Exxon and Shell, but British, French, Japanese, Brazilian and Chinese gas companies are also involved. In coal, the figures are almost as compelling. Of the 68 major new projects listed by ABARE, no fewer than 53 are partly or wholly foreign-owned. Roughly one-quarter of these are Chinese, another quarter Japanese and the rest is divided between the Swiss, Americans, Indians and South Africans. Even BHP has a Japanese partner, Mitsubishi, developing its three new Queensland mines, while Rio Tinto has a major Chinese shareholder in Chinalco (which owns 9% of the company) plus a variety of Japanese joint-venture partners in its Queensland coalfields.

The story is much the same in iron ore, except that China has no challengers. Here, 26 of 40 major new projects are Chinese-owned, Chinese-funded, have a Chinese joint-venture partner, or all three. Whether this amounts to selling the farm or just the produce is a moot point, but former treasurer John Dawkins says we have no need to worry. “The pity is that very few people have bothered to point out that our resources have only ever been developed with capital from overseas. First it was from Britain, then America, Japan and Korea, and now it’s the Chinese.”

“I can remember the apprehension when the Japanese turned up on the tarmac in Perth with their Qantas cabin bags wanting to buy our iron ore,” he says. “Well, we seem to have survived that OK, but now we’ve got the same reaction to the Chinese, and people like Barnaby Joyce are given the opportunity to whip up consternation about it all.”

One difference from those previous waves of foreign investment in Australia is that China’s buyers are almost all state-owned enterprises, which are ultimately owned and controlled by the Communist Party of China. “I can see why the Australian public might be concerned about that,” says David Olsson. “But should we fear it? I don’t think so.” “What could China do?” asks Dawkins, who now advises mainly Chinese companies about investing in Australia. “Some would say they could drive down the price of iron ore in this country to increase the profitability of their steel mills, but I really don’t see that happening. I can’t believe the tentacles of the Beijing government reach so far that they can get all their state-owned and private enterprises together to fix the price-setting process for iron ore.”

“I’m sure China would like to push us around more than it does,” he adds, “but I think Kevin Rudd handled the relationship pretty well. He employed a clever mixture of cosying up to them and giving them a bloody nose in response to their playing silly buggers. He understood them well enough to know when and how to engage.”

The last 18 months have seen relations between China and Australia get difficult at times. We have seen the collapse of Chinalco’s bid to double its stake in Rio Tinto, rows over iron ore price negotiations, rows over Australia’s Defence White Paper and, finally, the arrest and trial of Stern Hu on spying charges. But amid this atmosphere of fear and loathing, trade and investment has hardly hiccuped. Clearly, money and self-interest rule. Will they continue to do so? “Yes,” says Pengana’s Tim Schroeders. “I can’t see Chinese demand being satiated. Things have quietened down in Australia recently but they’ve been active in other parts of the world in oil and gas and they’ll be back when things get a bit shakier, providing finance and picking up equity stakes where they see fit.”

“There’s no sign of the Chinese steel industry slowing down,” says Garret Dixon. “They see our share market falling and ask what’s happening. The US is recovering, China is jumping ahead, they just can’t understand it.”

Certainly, some massive Chinese projects are still proceeding at full tilt. Up in the Pilbara, the Hong Kong unit of China’s biggest state-owned investment company, CITIC Pacific, is spending $5 billion on its Sino Iron mine and processing plant at Cape Preston, which will crank out 28 million tonnes of magnetite per year. To bring in power and water to the site, the company is using a Chinese construction company and Chinese workers to build a 450 megawatt gas-fired power station and a 51 gigalitre desalination plant, and to lay a 25-kilometre slurry pipeline to transport the processed ore to a new custom-built port.

The rights to this deposit were sold to CITIC for US$215 million by Queensland’s colourful self-made billionaire Clive Palmer, who was so vocal in his opposition to the ill-starred Resource Super Profits Tax. Palmer is also at the centre of Australia’s biggest new coking coal development, another project being driven by the Chinese. His China First Pty Ltd is planning a $7.5 billion coalmine, power station, port and 495-kilometre private railway in Queensland’s Galilee Basin, near Bowen. Five Chinese partners have agreed to fund and build the project, then buy all of its output for the next 20 years. “When you need a lot of money there is no better place to get it than in China,” says Palmer, who claims the new mine will provide 1500 long-term jobs (plus another 6000 during construction) and pay royalties of $700 million per year before the new Minerals Resources Rent Tax kicks in. But in future, Chinese investment won’t just be in mining and energy. “And this is where it’s potentially a bit more hairy,” according to Dawkins. “It’s going to be in agriculture, manufacturing, everywhere. It will be wine, meat and technology, anywhere they can invest. The plane that came out with Vice President Xi Jinping in June had more than 100 commercial people from Chinese corporations on board and they were interested in everything. I think their appetite is insatiable.”

“State-owned enterprises now have huge reserves and they need to put them somewhere,” says Dawkins. “They have been investing it in Chinese real estate and driving up prices but they can’t do that anymore; they have been encouraged to invest overseas, so they’re roaming the world looking for places to put their money.”

Olsson echoes this assessment: “China’s shopping trolley now includes assets in the food, agriculture and chemicals sectors, and intangible assets such as high technology, brands, patents and know-how.” And he adds, “It won’t be long before China’s focus turns to some of Australia’s high-profile rural and agricultural assets.”

However, they will not be the only ones kicking the tyres. “I think the world economy is returning to normal and I don’t think we’re going to be overwhelmed by the Chinese in coming years. We’re going to see more competition from India and other foreign buyers. We’ve seen it already with the Australian fertiliser manufacturer Nufarm, where Sinochem bid for the company and thought they had it in the bag then lost out to a higher offer from the Japanese, and also with CSR’s Sucrogen, where China’s Bright Food thought it had the deal locked up then lost out to a higher bid from Singapore.”

Wherever it comes from, we’re going to see more. As John Dawkins puts it, “There’s only one way to go and that’s up.”

Paul Barry flew to Atlas Iron and Gindalbie Metals on company charter flights.

Paul Barry
Paul Barry is a journalist and investigative reporter. He is the author of Who Wants to be a Billionaire? The James Packer Story and The Rise and Rise of Kerry Packer.

Cover: August 2010
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