FOCUS: Fortescue Up On China Deal, Future Prices Unclear
August 17 2009 - 4:11AM
Dow Jones News
A move by Fortescue Metals Group Ltd. (FMG.AU) to offer discount
iron ore prices to China in return for up to US$6 billion in
funding will underpin the miner's expansion plans, but raises
questions about the prices the firm will receive in the future,
analysts said.
Fortescue has struck a deal with the China Iron & Steel
Association to sell all of its iron ore fines to Chinese mills
until the end of 2009 at prices 3% lower than those Rio Tinto Ltd.
(RTP) and BHP Billiton Ltd. (BHP.AU) have agreed with steelmakers
in Japan, Taiwan and Korea.
The pricing deal appears designed to save face for CISA, which
has been refusing to accept the Japanese benchmark despite its
position being undermined by rising spot prices, and to attempt to
pressure Rio and BHP to fall into line.
The deal is conditional on Fortescue securing US$5.5 billion to
US$6 billion in funding from Chinese financiers to bankroll its
plans to up annual iron ore output from its mines in the Pilbara
region of Western Australia to 95 million metric tons.
While a 3% discount on six months of production might not be too
heavy a price to pay to win access to cheap funding for a
company-making expansion, analysts say there are still unanswered
questions and risks for Fortescue.
Namely; what will the terms of the finance agreement be and will
China now always be expecting a discount from Fortescue in the
future?
"The question has to be asked, what happens to your negotiating
position when you tie your balance sheet to your largest trading
partner," Macquarie analyst Brendan Harris said.
Asked if the Chinese would expect a discount from Fortescue in
the future, the miner's executive director of marketing, Russell
Scrimshaw, said it is too early to say.
"That is for time to tell, we are on day one of a Fortescue
price for the next six months," he told reporters.
Fortescue Chief Executive Andrew Forrest said the deal would
help China in its drive to establish more stable iron ore pricing
and that if this was achieved Fortescue would not be selling its
ore at a discount.
"You will see I think, Fortescue at least reaching parity with
the other producers," he said.
Fortescue's deal also features a guarantee from CISA that the
miner will have priority for negotiating iron ore prices in
2010.
UBS analyst Glyn Lawcock said the discount over the next six
months is not a big deal but there is uncertainty over what prices
Fortescue will receive for its ore in the future.
"The question is what commitments are behind (the deal) for
subsequent periods," he said.
Fortescue's agreed price of 94 cents per dry metric ton unit is
about 3% below the 97 cents Rio Tinto has agreed with other Asian
steelmakers, and equates to US$55.50 a dry metric ton of
Fortescue's iron ore.
With spot prices, on a free-on-board basis, surging to about
US$90 a ton, Lawcock said Fortescue's deal also denies it any
exposure to the upside of the spot market.
Macquarie's Harris also said the deal highlighted Fortescue's
lack of leverage to the spot market despite a recent tendency of
Fortescue's share price to track movements in the underlying
Chinese iron ore price.
Fortescue's stock rose on the news of the funding deal, closing
up 2.9% at A$4.58 in a broader Australian market that ended down
1.6%. Still, Fortescue's closing price was below an intraday high
of A$4.75. Several analysts said the stock price has run ahead of
the miner's production, and is already pricing in its
yet-to-be-delivered expansion.
Analysts also made the broader point that the deal is part of a
push by China to encourage the development of new sources of iron
ore and that this, along with the current high prices, was helping
new producers get started with the new supply likely to drive
prices lower in the long run.
"China's strategic aim to encourage as much iron ore production
as possible has the ability to undermine the historical high
returns that iron ore has generated," Citi analysts said in a
client note.
-By Alex Wilson, Dow Jones Newswires; 61-3-9292-2094;
alex.wilson@dowjones.com
(Elisabeth Behrmann in Sydney contributed to this story)