By Wayne Arnold
CAPE PRESTON, Australia--A $10 billion iron-ore mine that has
taken more than eight years to develop near this remote Australian
port is a glaring example of how much has gone wrong with China's
decadelong push to buy up raw materials around the world.
Citic Pacific's Sino Iron mine cost roughly four times its
initial budget, and analysts who track the project say it likely
will lose hundreds of millions of dollars in 2014, its first full
year of production. Citic Pacific, a Hong Kong-listed subsidiary of
Chinese state-owned behemoth Citic Group, and its contractors made
a series of blunders, from thinking they could import workers at
Chinese pay levels to a botched bet on currencies that forced the
company to seek a $1.5 billion bailout from its parent.
And while Sino Iron is at last shipping ore, it remains locked
in a legal battle with its local partner, Clive Palmer, a property
mogul turned politician who has accused Citic Pacific of taking
Australian resources without fully paying for them.
"It was a painful learning process," said Zhang Jijing, who
spent 16 years running Citic Group's Australian business before
being appointed in late 2009 president and executive director of
subsidiary Citic Pacific, which recently changed its name to Citic
Ltd. "Today I look back and I did not realize it would be so
difficult."
Over the past decade, China rushed to buy up global commodities
as its economy boomed--both to feed its factories and to ensure it
wasn't reliant on Western powers for raw materials. China's
overseas investments in resources soared to $53.3 billion last
year, from $8.2 billion in 2005, according to an investment
database compiled by the American Enterprise Institute and the
Heritage Foundation.
Now it is becoming clear that China's shopping spree yielded
numerous bad investments. Many big-ticket deals are losing money,
running into unexpected costs or generating significantly less
output than expected. Some Chinese investors are moving away from
resources--a shift that could mean less Chinese money for countries
in places like Africa, Latin America and the Middle East.
The reasons for China's struggles vary. China came late to the
global resources boom and often overpaid for assets Western
companies had passed over or wanted to sell. China typically paid
one-fifth more for oil-and-gas assets than the industry average,
estimates Scott Darling, Asian regional head of oil-and-gas
research at J.P. Morgan Chase & Co.
China Petroleum & Chemical Corp., also known as Sinopec,
paid $4.65 billion in 2010 for ConocoPhillips's stake in Canadian
oil-sands company Syncrude Canada Ltd. The price was a 10% premium
to the asset's market value at the time, gauged by the market
valuation of its largest shareholder, Canadian Oil Sands Ltd. The
project subsequently was dogged by rising costs and falling
production, according to financial disclosures by Canadian Oil
Sands.
Sinopec said the Syncrude project was the only oil-sands project
of its scale available at the time and that the price was
reasonable. Syncrude's production and profitability were stable
until recently, Sinopec said, and Sinopec expects the project to
produce for 60 years. "So the project could still be considered as
a qualified profitable one in the long term," it said.
Cnooc Ltd. paid $15.1 billion in 2012 for Canadian energy
producer Nexen Inc., whose net profits are now less than one-fifth
what they were in 2010. The company has suffered from lower
natural-gas prices, declining output from some key fields and other
problems.
Cnooc said that Nexen's performance since the merger was in line
with its expectations and its assets were operating smoothly.
In April, Iran canceled a $2.5 billion deal with China National
Petroleum Corp. to develop an onshore oil field called South
Azadegan after Iranian officials alleged China was overcharging for
drilling equipment and services and causing projects to be delayed.
A month earlier, Iran's deputy petroleum minister, Mansour
Moazzami, said CNPC was at risk of losing its $4.7 billion contract
to develop the giant South Pars gas field because it had failed to
make sufficient progress. CNPC didn't respond to requests for
comment.
Mining and energy projects are difficult by nature, and Western
resource companies often run into troubles of their own. Some
analysts say China is simply waking up to the hard realities that
Western companies have long confronted in such projects.
"The world is littered with projects that have had massive cost
overruns, " said Megan Anwyl, executive director of the Magnetite
Network, a mining-industry lobbying group in Perth.
Some of China's bad deals could still pay off if global
commodity supplies become tight and prices rise. A few of China's
major deals, including Sinopec's $3.5 billion purchase of oil
assets from Russia's OAO Rosneft in 2006, appear to be either
profitable or close to breaking even, according to company
disclosures and news reports.
Big new Chinese deals are still being done. In April, a unit of
China Minmetals Corp. led a consortium to purchase a Peruvian
copper mine from Glencore Xstrata PLC for $5.85 billion.
But Chinese officials acknowledge difficulties. Last year, the
head of China's mining association estimated that 80% of all
overseas mining deals had failed, though he didn't elaborate,
according to state media.
China's National Audit Office in June blamed mismanagement for
losses on at least 10 foreign investments by China Investment
Corp., the $600 billion sovereign-wealth fund that bought tens of
billions of dollars in resource-related holdings between 2009 and
2012. The office didn't specify which deals.
CIC has begun shifting away from energy investments and into
other sectors, according to people familiar with the fund. Energy
and metals deals fell to two-thirds of China's offshore investments
in 2013, from 80% in 2005, according to the American Enterprise
Institute and Heritage Foundation data, and China's $53.3 billion
in resource investments last year was below the record $57.5
billion in 2011.
China's Ministry of Commerce said it had stepped up efforts to
vet overseas investments and make companies more aware of the risks
and responsibilities they face abroad.
"The government said from now on this 'buy any resource at any
price' is finished," said Por Yiang-liang, an analyst at BNP
Paribas in Hong Kong. "It's a complete reversal of the past
decade."
Citic Pacific's misadventures in northwestern Australia suggest
why China is changing course.
Citic Pacific signed its deal with Mr. Palmer, a property tycoon
who owned rights to mine iron ore around Cape Preston, in March
2006. Citic Pacific wanted to feed three steel mills it operates in
China.
Iron-ore prices were soaring at the time, and Beijing was eager
to break the dominance of BHP Billiton Ltd., Rio Tinto PLC and Vale
SA of Brazil, which together controlled more than 70% of the
world's seaborne iron-ore trade.
Citic Pacific paid Mr. Palmer's company, Mineralogy Pty. Ltd.,
an initial $415 million and agreed to invest $2.5 billion to build
the project and a port, with production slated to begin by 2009. It
also agreed to pay Mineralogy royalties on every ton of ore it
produced, and a penalty if by 2013 it wasn't producing at least 6
million tons a year.
Miners in the area had long focused on iron-ore deposits called
hematite that could be shipped without processing. Cape Preston's
ore is poorer-quality magnetite, which must be concentrated before
it is sold. Citic Pacific would have to build six processing
plants, which also would require a power plant and desalination
facility for water needed to run the operation.
Within six months of winning Australian government approval for
its investment, Citic Pacific gave a $1.75 billion contract to
build the project to Metallurgical Corp. of China, or MCC.
"I don't know why everything was pushed in such a hurry in the
beginning, " said Mr. Zhang, the Citic executive. Preparing such a
big project, he said, would normally take two years.
Australian consultants had said a project half the size would
take $5 billion and five years to complete. China's MCC said it
could do it for $2.5 billion in just three.
Officials at MCC didn't respond to requests for comment. In its
2012 annual report, the company said that "preparatory works from
both sides were insufficient" and that the "project was commenced
hastily without full understanding of the Australia laws," among
other issues.
Sino Iron was bigger than anything MCC had built in China, Mr.
Zhang said. The mine uses seven-story crushers in the pit and a
mile-long conveyor belt to carry rock to processing lines.
The area's magnetite turned out to be much harder than magnetite
in China and wore out equipment. The ore also is riddled with
asbestos, according to Citic Pacific financial disclosures, so the
company had to invest in airtight vehicles to prevent workers from
breathing the carcinogenic fibers.
Officials at MCC wanted to import inexpensive Chinese workers
but faced obstacles, Mr. Zhang said.
Australia only gives workers visas if they speak English and
pass Australian qualification exams. Those that pass have to be
paid no less than an equally qualified Australian, with standard
benefits such as a week off for every three on site and flights to
and from Perth.
In the end, MCC was only able to bring in a few hundred Chinese.
Each of the 1,000 miners working at Sino Iron, Mr. Zhang said,
costs the company more than $200,000 a year, including benefits and
other expenses.
Complying with Australia's environmental and cultural
regulations was another headache. Sino Iron, for example, worked
with Aboriginal communities to protect or move sacred sites.
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The costs were in Australian dollars, which strengthened against
the U.S. dollar between 2007 and the time construction started in
August 2008. To protect itself from currency losses, Citic Pacific
bought currency-related derivatives that backfired when the global
financial crisis struck.
In October 2008, facing more than $2 billion in potential
losses, Citic Pacific took a $1.5 billion bailout from its parent,
Citic Group.
Citic Pacific enlisted Mr. Zhang, who wasn't involved in the
project until then, to become its executive director. Mr. Zhang
agreed to increase Citic Pacific's payments to MCC, which
eventually paid MCC a total of $3.4 billion.
Sino Iron also was clashing with Mr. Palmer, who after striking
his deal with Citic Pacific had invested in a soccer team, a nickel
refinery and a golf resort that he turned into a dinosaur theme
park. In 2012, he announced plans to build a replica of the
Titanic. Last year he established his own political party, the
Palmer United Party, and won a seat in Parliament.
Analysts estimated Sino Iron's delays were costing Mr. Palmer
hundreds of millions of dollars a year in royalties.
In October 2012, Mineralogy issued a notice terminating Citic
Pacific's mining rights, alleging that it had not been paying
royalties due. Citic Pacific acknowledges it wasn't paying
royalties but argued it didn't need to because it wasn't yet
shipping any processed ore.
A court eventually ruled Citic Pacific would have to start
paying those royalties. But when Citic Pacific's additional penalty
for not producing 6 million tons a year--equivalent to about 10% of
the expected sale value of processed ore--came due last year, the
company said it wouldn't pay until the two sides could agree to a
pricing formula. They are in mediation.
"We're confident before the courts," said Andrew Crook, a
spokesman for Mr. Palmer. "We'll let them sort it out." Mr. Palmer
declined to comment.
In July, Citic Pacific sued Mr. Palmer for fraud, alleging he
siphoned $11.2 million from an account for operating the port, part
of which allegedly was used to pay for his party's political
campaign last year. Mr. Palmer has denied wrongdoing, but created a
diplomatic stir in August. When asked about the accusations on
Australia's ABC television, he accused China of wanting to bring in
workers to Australia, among other things. "I don't mind standing up
against the Chinese bastards and stopping them from doing it," he
said, referring to Citic Pacific as "mongrels." He continued: "I'm
saying that because they're communist, because they shoot their own
people, they haven't got a justice system and they want to take
over this country."
Citic Pacific declined to comment on Mr. Palmer's remarks, for
which he subsequently apologized. Mr. Palmer said his comments
"were not directed at the Chinese community or the Chinese
government."
Last December, Citic Pacific fired MCC, taking over the
construction of the mine's last four production lines. It held a
simple ceremony to mark its first shipment of iron ore from Cape
Preston to China.
In February, Citic Pacific disclosed its latest tally for the
project: $9.9 billion in investment and $3.6 billion in debt to
build an asset the company values at less than $7 billion.
Its iron-ore division, which only includes the Australia mine,
lost more than $208 million last year, according to its annual
report, in which its chairman said it may lose more as expenses
mount.
Mr. Zhang said costs would come down once the remaining four
lines are completed. He said it would take a couple of years more
before the mine is running at full capacity. But the worst of the
mine's troubles, he predicted, are behind it.
Chester Dawson, Benoît Faucon, Ned Levin, Drew Hinshaw, Joy Ma,
Wayne Ma, Brian Spegele, Lingling Wei and Kersten Zhang contributed
to this article.
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