The Ore Wars – the Australian Iron Ore Industry

John Rice

On November 22, 1952 Lang Hancock and his wife Hope were flying from their grazing property in the north of Western Australia (WA) to Perth. Hemmed in by bad weather, he piloted his single engine plane low into the gorges of the Turner River, in WA’s Pilbara region. He noticed the walls of the gorge were a deep red. Returning soon after with a geologist, he realised he had found an iron ore deposit in Pilbara’s Hamersley Ranges that extended over 100 kilometres in length. The iron ore deposit was one of richest and most significant on Earth, and Hancock soon staked his claim.

So began the history of the Pilbara’s iron ore industry. In the decades since, fortunes have been made and lost by many colourful characters and multinational firms alike. Today, iron ore is one of Australia’s largest and most profitable exports. Australia’s iron ore industry extends well beyond the Pilbara, but the Pilbara still holds the mother lode for this vital commodity.

The story of Lang Hancock continues to this day. Hancock’s daughter, Gina Rinehart, continues to head Hancock Prospecting, the privately owned firm that owns the Hope Downs and the Roy Hill deposits in the Pilbara. The Hancock family’s wealth is estimated at more than $30 billion dollars in 2014 and is the source of internecine familial disputes that are often widely reported in the Australian media.

This case provides information to allow readers to understand the attractiveness of the iron ore industry and why it has proved to be one of the most profitable industries in Australia in recent years.

Iron Ore

The Earth, by most estimates, is around 4.5 billion years old. Around 3 billion years ago, plants formed that converted carbon dioxide into oxygen. Some of this oxygen was dissolved into the Earth’s oceans, reacting with dissolved iron oxides to produce insoluble iron oxides (that is, iron-based solids that cannot be dissolved) that in turn settled on the ocean floors. It is these layers of iron oxides that are today mined around the world as iron ores.

The iron concentration, and thus quality, of these ores varies greatly. Historically, many types of ores have been mined, but today the main iron ore that is mined is hematite (Fe2O3). This hematite often coalesces with other elements, including water, phosphorous and clays. From an economic point of view, the higher the concentration of hematite (and the lower the concentration of these impurities), the better. Some impurities are particularly bad – for example high levels of phosphorous are hard to remove during smelting and make the final steel brittle.

As hematite iron ore prices have increased, other iron ores have also become economically viable. An example is magnetite (Fe3O4) which is also mined in the Pilbara by the ebullient billionaire cum politician, Clive Palmer and his Chinese partners.

When the iron content of these ores exceeds around 60%, it is considered a ‘direct shipping ore’ (DSO) and can be sent relatively unprocessed to steel mills. Global reserves generally include only

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high quality ores, or lower quality ores that are close to the major markets. Lower concentrations are often mined, but these generally require additional processing that is often very costly.

Poorer ores, with lower iron concentrations, are mined and refined (through a process known as beneficiationi that utilises a combination of magnetic separators and gravity separators) to increase iron concentrations. Such refined ores generally have iron concentrations above 65%, and hence command a market premium. However, the processes and capital involved in beneficiation are expensive, often doubling the costs of producing ores in comparison to the production of low cost, ‘direct shipping ores’ (DSO) that are dug up and shipped with little or no processing.

Beneficiation is extremely costly – both in terms of up front capital costs and ongoing expenses. The lowest average production costs per tonne for direct shipping ores in Australia is around $30-40 per tonne, while ores that have been mined and then beneficiated generally cost from $80 to $100 per tonne. Beneficiated ores generally have slightly higher market values than direct shipping ores, as the iron content is generally in the 65% plus Fe range – but this market premium does not compensate for the extra costs.

Some deposits are thus more valuable than others. Other things being equal, DSO deposits are the most profitable. Some of the best quality iron ore is found in India and in western Africa. Much of the Indian production, however, is used domestically and exports from India are limited. West Africa has enormous potential, but significant political and sovereign risk in countries where the iron is located has made multinational miners wary of investing the necessary billions of dollars to bring those deposits into production.

Ideally, multinational miners like large deposits of high grade direct shipping ores with low impurities. This describes Australia’s Pilbara iron ore reserves, which are the largest among producer nations and some of the best in terms of quality. China has large reserves, equivalent to Australia’s, but much of the ore is of low iron concentration, and thus of poor quality and expensive to refine into steel.

Brazil is the other major producer and exporter, led by the former government owned firm Vale. Vale produces the bulk of Brazil’s DSO iron ore (around 300 million tonnes in 2012, alongside around 45 million tonnes of iron ore pellets that have been refined from lower quality ores.

As is the case for many mineral resources, Russia is a sleeping giant, with large high quality reserves and comparatively low production levels. In central Russia, the Kursk magnetic anomaly is the largest single iron ore reserve on Earth. While much of the easily mined ore has been depleted in Soviet and post-Soviet times, new investment could bring on line massive new mines with relatively low production costs. Around 80% of Russia’s production of iron ore is used domestically, making it a small player in the globally traded iron ore marketplace (Russia exports around 20 million tonnes per year, mostly to former Eastern bloc nations in Eastern Europe while Australia exports around 450 million tonnes per year, mostly to China). Russia’s potential to invest in new iron ore mines in central Russia, the Urals and Siberia, however, indicate that it could be a large producer in the future.

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Table 1: World Production and Reserves of Iron Ore

Production (2012) Million Tonnes

ReservesMillion Tonnes

Average Fe (Iron) per tonne in reserves

Australia 488 35000 49%Brazil 373 29000 55%Canada 34 6300 37%China 1330 23000 31%India 240 7000 64%Iran 28 2500 56%Kazakhstan 25 2500 36%Mauritania 12 1100 64%Mexico 15 700 57%Russia 100 25000 56%South Africa 60 1000 65%Sweden 25 3500 63%Ukraine 81 6500 35%United States 55 6900 30%Venezuela 17 4000 60%

Source: United States Geological Survey - http://minerals.usgs.gov/minerals/pubs/commodity/iron_ore/

The Iron Ore Market

For decades iron ore was a cheap and relatively unprofitable commodity to produce. Australia’s reliance on the export of basic commodities like iron ore, coal, gold and wool was once seen as the basis for its national economic malaise. Its lack of an efficient manufacturing sector, and the slow long term decline in the relative value of basic commodities compared to manufactured goods, was seen to be providing Australia with a slow ride to economic decline.

China has emerged over the last decade as Australia’s largest market for iron ore. Its demand, driven by its rapid industrialisation, has complemented existing markets in Japan, South Korea and Taiwan – all countries with significant and longstanding steelmaking industries.

Iron ore prices, however, increased by eight times between early 2005 and early 2011, from around USD 20 per tonne to more than USD 180 (see Table 2). The reasons for this are discussed later in this case. This radical discontinuity in prices has had serious and profound impacts on the iron ore industry, and indeed on Australia’s economy as a whole.

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Table 2: Iron Ore Prices – 2003 to 2013 – USD per tonne, 62% Fe Spot Price

Source: http://www.indexmundi.com/commodities/?commodity=iron-ore&months=120

Iron ore is traded on two related markets – the ‘spot’ market and the market for long term supply contracts. The spot market for iron ore can be extremely volatile, depending on the vagaries of the weather, political strife in exporting nations and annual economic and production cycles.

Prior to 2009, iron ore prices for most Australian sellers were determined by a benchmark process. In essence, BHP and Rio negotiated, in secret, a benchmark price each December that would be the basis for subsequent annual sales. BHP successfully agitated against these arrangements, moving to a more fluid, spot based market mechanism in 2009 that coincided with the significant increase in prices and revenues achieved by the large miners.

Large buyers of iron ore generally dislike buying it on the spot market – especially when prices are increasing. Long term supply contracts, as well as providing some certainty on costs, also tend to allow for ores of a certain quality to be supplied. Ore furnaces are often designed with certain ores in mind, and large suppliers can and do blend ores from different mine sites to provide an ore of a certain Fe (iron) concentration. Likewise, some steel companies have developed furnaces that work best with ore concentrates, processed ores with clays and impurities partially removed. These concentrates are often processed to an intermediate level into ‘pellets’ with higher levels of Fe that command premium market prices.

Also, steel mills in China relying heavily on the spot market for supply were acutely squeezed as the spot price trebled from mid 2009 to mid 2010. Many of these mills moved to ensure that this uncertainty was removed from their operations by developing long term supply arrangements with particular producers or particular sites owned and run by large producers under joint venture arrangements.

As a general rule, producers prefer spot prices and consumers prefer long term contracts. Long term contracted supply is generally restricted to production from joint ventures, where the final customer has made a significant capital investment up-front in the development of the ore body.

The ongoing balance between these two market arrangements (spot versus contract) is a constant source of tension in the industry. Generally, Chinese buyers are vociferous in their accusations that

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the large sellers act in concert to manipulate prices. In December 2013, Nev Power, the FMG CEO was quoted as saying, in the context of accusations of market manipulation by the large sellers to inflate iron ore prices:

“CISA (China Iron and Steel Association – a Chinese government agency) loves beating their drums about it but they don’t do anything, they just talk about it, and threaten and sabre-rattle.

… I understand that as a country, they want to make sure the price is fair and transparent. The price is fair and transparent – it is just the market that moves it”.ii

In 2012, globalORE™, a trading platform for iron ore, was established by Baosteel, BHP, Glencore, Hunan Valin, Minmetals, Rio Tinto and Vale. It established clear market rules, and quality benchmarks to assist in comparing various ore grades available from established and emerging producers.

In the United States, scrap metal has emerged as a viable alternative to iron ore in the production of steel. Large recycling firms like Nucor have developed ‘mini mills’ throughout the United States to smelt used scrap steel into new final products using electric arc technology. In China, and in much of Asia, the limited availability of scrap steel has meant recycled steel has been less important. Around one third of the United States’ steel production is from recycled steel, while in China this figure is around ten percentiii.

As time passes, scrap steel becomes a more viable substitute for iron ore in developing countries as the availability of scrap steel, after its useful life is completed, increases. For example, China is now the world’s largest car market, and as its car fleet ages, more scrap steel will become available for recycling.

Iron Ore’s Uses

Iron ore has one main purpose – as the main component in the production of steel. Steel is an alloy of iron and carbon. Some forms of steel have additional alloying elements added (for example including chromium and other alloying elements to make stainless steel). By weight, most steel is used in construction (for buildings, railways and infrastructure). Steel is also used in the manufacture of cars, appliances and myriad other products. Generally, the value of the steel used in a product is a small component of its final value.

A very typical structural steel product is an I-beam (or universal beam) that you often see in construction of tall buildings or multi-level car parks. Steel can also be rolled into plates and then pressed into panels for use in whitegoods, cars and aircrafts (among thousands of other uses).

Iron Ore and the Environment

The mining, transportation and processing of iron ore to its final products has fairly significant and negative environmental impacts. The creation of steel from iron ore is very energy intensive, with much of this energy coming from the burning of coal and other fossil fuels . Every tonne of steel requires around 1.5 tonnes of ore (at around 66% Fe concentration) and around 800 kilograms of coking or hard coal.

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This process, in turn, releases around 2 tonnes of carbon dioxide (CO2), and depending on the impurities in the ore, various other greenhouse inducing and toxic gasses (for example, carbon monoxide and sulphur dioxide). Even these figures ignore the CO2 produced in the steelmaking value chain – in the extraction and transportation of ores from mines to steel mills and later transport to customers. Overall, steelmaking is a significant contributor to global CO2 levels.

The demand for steel is disproportionately high in developing economies. As nations like China, India, Korea and Vietnam have modernised, they have needed steel to build their railway tracks, major buildings and to feed their manufacturing sectors.

In 1997 (effective from 2005) many industrialised countries signed the Kyoto Protocol which was aimed at reducing the emissions of greenhouse gases (GHGs). In Asia, the only nation to sign the agreement was Japan, leaving other major emitters like Taiwan, Korea, China, Vietnam and India relatively unconstrained in terms of their CO2 and other GHG emissions. While not an issue in 1997, it has become a major issue in 2014. Whether this arrangement is sustainable over the longer term is questionable, as CO2 produced anywhere has the same detrimental consequences. As such, reducing GHGs will be an emerging challenge for all countries in the future, and steelmaking will be one of the industries that must change.

Iron Ore and Government Policy

Governments are strong supporters of the iron ore industry. In Australia, the West Australian government has facilitated the growth of the industry by completing agreements to allow rail and port access through government owned land. In turn, the industry pays huge royalties to the government – in the FY 2011-12, Western Australia received almost $4 billion in royalties from iron ore miners.

National governments in developing countries also take an active interest in the iron ore industry. Nations like China, India and Vietnam are modernising fast, and almost every aspect of their economic and social transformation relies on steel. It is in these nations’ interests to maintain a steady supply of steel at low prices to ensure their infrastructure, building and manufacturing sectors can thrive. To facilitate this, Asian government build important commodity logistics infrastructure to support often State-owned processing and refining companies.

Compares to western nations, developing Asian nations also have lax environmental regulations. China, for example, is the largest consuming nation for both coal and iron ore – the consumption and processing of which contribute significantly to the creation of environmental problems.

Iron Ore’s Suppliers

Digging up, beneficiating, moving and shipping iron ore is an expensive business. The mine sites in the Pilbara host hundreds of massive trucks which when loaded weigh around 500 tonnes, cost around $5 million to buy and around $1 million per year to run – in staffing costs alone. These figures point to a buoyant ‘sellers’ market’ for companies and workers who sell their products and services to the iron ore mining industry.

The two largest suppliers of these monster trucks – Japan’s Komatsu and America’s Caterpillar – have both seen significant sales increases to Australia’s resource sector in recent years.

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Generally, large suppliers like Caterpillar have seen significant global growth in demand for its mining equipment. The following table is illustrative - as can be seen, sales of Caterpillar’s resource industry machinery has increased from around USD6 billion in 2009 to more than USD 21 billion in 2012. Caterpillar’s success has been a product of growth in the global resources sector.

Table 3: Caterpillar Segment Revenues – 2009 to 2012

Segment Revenue 2009 2010 2011 2012Construction 8,507 13,572 19,667 19,334Resources 5,857 8,667 15,629 21,158Power Systems 13,389 15,537 20,114 21,122Financial 3,139 2,946 3,003 3,090Other 1,504 1,866 1,725 1,171Total 32,396 42,588 60,138 65,875

Resources Share 18.08% 20.35% 25.99% 32.12%USD Million - Source: Caterpillar Annual Reports

Specialist and highly trained workers are also in great demand and limited supply in the Pilbara and elsewhere in the Australian iron ore industry. In mid-2013, headlines were made when BHP confirmed many of its specialist iron ore train drivers in the Pilbara commanded annual earnings in excess of $240,000 in 2012iv.

Future technological developments may well see further automation and use of robots on mine sites and in trains, but this will tend to see greater relative spending on technology and less employees – though those workers that remain will still be highly trained and very well paid.

World Market Demand and Prices

China’s extraordinary economic transformation since Deng Xiaoping’s economic reforms of the late 1970s have been built on steel – and this demand for steel has been fuelled by the Pilbara region While China has massive domestic reserves of iron ore, much of it is of poor quality in terms of its Fe (iron) content. China has emerged as the world’s largest importer of iron ore and most comes from the massive Pilbara deposits of the Rio Tinto/Hancock Prospecting joint venture, and from BHP Billiton’s massive open cut series of mines at Mt Whaleback which are joint ventures with a variety of Japanese partners.

Most iron in Chinav is made in blast furnace smelters. Essentially, iron ore is burned at high temperatures in the presence of carbon fuels (generally coking coal) to produce molten metal, solid slag (or waste) and, of course, plenty of carbon dioxide and other gaseous waste.

An intermediate product produced by these large blast furnaces is pig iron – an alloy of iron and carbon that is generally brittle and of limited final use. Pig iron ingots are then fed to steel mills, where sulphur, phosphorus, and excess carbon are removed (each producing toxic or harmful gasses) and alloying elements like manganese, nickel or chromium are added to produce the exact steel alloy specifications required by the final customer.

China has sought to diversify the suppliers of its iron ore – both from other Australian producers and globally. China’s Baosteel (a state-owned iron and steel company) is a large customer of, and investor in, operations of Fortescue Metals, Australia’s third largest iron ore producer. Other direct

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and indirect Chinese government investment in Australia’s iron ore industry includes an (often tempestuous) joint venture between CITIC Pacific (majority Chinese government owned) with Clive Palmer’s Mineralogy Group to develop a large magnetite ore body in the Pilbara, a joint venture between the State owned Ansteel and Gindalbie Metals in WA’s mid-west.

<< Insert Map of Pilbara producer mines and assets, perhaps with a blow up for mid-West producers and the NT operations of WDR >>

Both the major players, BHP Billiton and Rio Tinto, are also involved in significant joint ventures with Chinese State Owned firms. BHP, for example, operates a joint venture involving the State owned Wuhan Iron and Steel Group, Itochu Minerals & Energy (Japan), Mitsui Iron Ore Corporation (Japan) TangSteel (China – State Owned), Maanshan Iron & Steel (China – State Owned), and Jiangsu Shagang Group (China – one if the largest Chinese Privately Owned companies). Rio Tinto and Sinosteel also jointly run the Channar joint venture near Paraburdoo in the Pilbara.

These processes of upstream investment by Chinese steel mills have had a notable and significant impact on the Australian iron ore industry. Arguably, without Chinese support in terms of both debt and equity, many of the minor players in the Australian iron ore industry would never have emerged, and much of the investment in the Pilbara by Rio Tinto and BHP Billiton would not have occurred.

Major, Medium and Minor Players in the Iron Ore Industry

There are three large international iron ore export-focused miners – Rio Tinto, BHP Billiton and Vale. Both Rio Tinto (‘Rio’) and BHP Billiton (BHP) have strong Australian historical connections and both have major current iron ore operations in the Pilbara. Vale, on the other hand, is based and has most of its operations in Brazil.

All three companies are diversified miners, but a large share of Vale’s revenues come from iron ore. Around 71% of Vale’s revenues are from iron ore (it also mines coal, nickel, copper and potash, among other things), while for BHP around 34% of revenues are from iron ore and for Rio, around 44% of revenues are from iron ore.

Table 4: Firms’ Strategies

Excerpts from Rio Tinto Strategy Statement …

We are confident that our strategy remains the right one: to invest in and operate large, long-term, expandable, low-cost mines and businesses, driven by the quality of each opportunity in the most attractive industry sectors.

We are convinced of the benefits of owning a diversified asset portfolio, as this will enable us to supply global markets at all stages of development. But only if this is achieved in a way that maximises value for our shareholders. So we look for high-quality assets in the right industry sectors that provide superior returns throughout the economic cycle - with options for growth when the time is right.

When managing and allocating capital, we balance investment to grow the value of the business and returns to shareholders, while aiming to maintain a strong balance sheet and retain our single A credit rating.

Excerpts from the BHP Strategy Statement …

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Our strategy is to own and operate large, long-life, low-cost, expandable, upstream assets diversified by commodity, geography and market. Our strategy has remained unchanged for over a decade and has enabled us to deliver superior margins throughout economic and commodity cycles for many years.

Our diversified, low cost, tier one asset base enhances the resilience of our cash flow by reducing our exposure to any one commodity or currency and provides for more predictable and robust financial performance. It allows us to invest in and grow our business throughout economic cycles thereby delivering superior long-term value to our shareholders.

Excerpts from the Fortescue Vision and Values Statement …

Our vision at Fortescue is to be the lowest cost, most profitable and safest iron ore producer. To achieve this we focus on getting the best from all our people by ensuring that the unique culture and environment is upheld through our vision and values.

We are a family and our culture is what guides our actions and helps us to succeed. We are committed as one team and as such we think of the whole business in everything we do, not just our part.

Vale’s Mission, Vision and Values …

Mission - To transform natural resources into prosperity and sustainable development

Vision - To be the number one global natural resources company in creating long term value, through excellence and passion for people and the planet.

Values 1. Life matters most2. Value our people3. Prize our planet4. Do what is right5. Improve together6. Make it happen

Table 5: Selected Australian Iron Ore Producers (Plus Brazil’s Vale) - Year Ending 30 Dec, 2012, $Million

Vale (USD)

BHP (USD)

Rio (USD) Arrium (AUD)

Fortescue (USD)

Atlas Iron (AUD)

Mount Gibson (AUD)

Revenue (Corporate) 47694 65968 55171 3404 3301 618 416Iron Ore Revenues 33978 22601 24279 791 3301 618 416Net Income (Corporate)

5511 10876 9303 243 478 98 52

Source: Companies’ Documents, Annual and Quarterly Reports

Within Australia, there is one significant second tier (based on iron ore revenues) producer of iron ore – namely Fortescue Metals Group. This firm, headed by Andrew Forrest (nicknamed Twiggy) since 2001, produces around 15% of the iron ore of BHP and Rio – also from the Pilbara region.

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There are a larger number of third tier players, including a number in production (for example, Atlas Iron and Mt Gibson Iron – both based in Western Australia and the US firm, Cliffs Natural Resources, which produces around 8.5 million tonnes of DSO ore at its Koolyanobbing mine that is around 400 kilometres northeast of Perth in WA’s south).

Within the minor player group, there is a variety of smaller producers or potential producers, including Western Desert Resources – a firm with a large deposit in the Northern Territory that is due to commence exporting in late 2013, Grange Resources, with a mine and concentrating plant in northern Tasmania and Gindalbie Metals, with an operating mine located around 1000 kilometres south of the Pilbara region and east of Geraldton in the mid-west region of Western Australia.

Vertical Integration – Through Ownership and Alliances

One of the Australian companies listed above – Arrium – is quite different from the others. Arrium was recently renamed from OneSteel, which was in turn spun off from BHP in 2000. Arrium is somewhat vertically integrated, producing both iron ore from its mine in the Middleback Ranges in South Australia and also producing steel from its Whyalla Steelworks around 200 kilometres north of Adelaide, at the top of the Spencer Gulf. The Middleback Ranges mine was a legacy asset of BHP when it produced both steel and iron ore. When it spun off the steel business, the South Australian mine was deemed not to fit with the new Pilbara focus, and was thus transferred to the new steel entity. This provided the basis for the vertically integrated Arrium we see today.

No other Australian iron ore producer is directly involved in steel production.

Some producers (for example, Grange Resources) do some limited local value adding – in Grange Resource’s case by refining and ‘pelletising’ lower quality ores for export.

While vertical integration (mining ores, and making steel within the one firm) is rare, strategic alliances between ore miners and overseas steel mills is common. The big two (Rio and BHP) have developed significant reserves into mines in partnership with Asian steel mills. Many of the smaller producers are also developing long term supply relationships with Asian steel mills. These relationships can span long term purchasing (for example, Noble Resource’s five year ‘offtake’ agreement with Western Desert Resources to buy ores from its Northern Territory mine) to significant equity and debt investments into joint venture operations (as is the case for Gindalbie Metals and China’s Ansteel).

Australia’s Iron Ore Producers

In the following section, three Australian iron ore producers are discussed as examples of small, medium and large producers.

Table 6: Select Producers

Million Tonnes -> Ore Proven Ore Probable Ore Production 2014 Projected

Rio (Pilbara) 2,125 1,138 260Fortescue (Pilbara) 547 1,797 180Western Desert (NT) 135 476 3

Source: Companies’ Annual Reports

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An Emerging Small Miner – Western Desert Resources

In 2008, a significant hematite ore body was discovered at Roper Bar in the Northern Territory, in arid country around 400 kilometres south east of Darwin around 100 kilometres from the Gulf of Carpentaria coast. Tenements covering part of these deposits were acquired by Western Desert Resources soon after, and investments began to develop the resource into an operational mine.

By late 2013, when production and exports commenced, Western Desert had undertaken extensive analysis of the ore body under its tenements. It was estimated that the Roper Bar project has a total ore body of around 600 million tonnes (at around 40 per cent Fe), with a more concentrated DSO section measuring 47.4 million tonnes at 57.3 per cent Fe. Importantly, the technical challenges of the ore body related mostly in the logistics of getting it to port – the high grade DSO was easy to mine – essentially it is classed as a drill/blast/truck/ship operation which is about as technically simple as iron ore mining can be.

There are, however, some challenges in extracting iron ore from such a remote location. There is little infrastructure in that part of the Northern Territory, and Western Desert had to build a road from its mine to the coast and port facilities to allow it to export its ores.

These efforts began in earnest over the period 2009, culminating in project approvals in mid-2011 and commencement of mining and export in late 2013.

Western Desert are projecting exports of around 3 million tonnes per year from 2014 of the DSO resource. The private, sealed road from the mine to the port, and associated infrastructure, has cost the company around $200 million to build. Lower grade beneficiable ore will be stockpiled for later processing if possible. The operating costs for the DSO operation, per tonne, is estimated in the $60-70 per tonne range.

A Mid-Tier Producer - Fortescue Resources

In May 2001, Andrew Forrest had been ousted as CEO of Anaconda Metals under difficult circumstances. Anaconda had almost gone bankrupt, with Forrest as CEO, after it failed to deliver on promises made to investors in relation to the development of a large nickel mine in Western Australia. Spending 2002 in Europe on holiday with his young family, he returned to Perth in early 2003 looking for a new challenge.

He ended up taking on Allied Mining and Processing (soon renamed Fortescue Metals Group, FMG), a small miner with some undeveloped iron ore tenements around 100 kilometres north of Rio’s Pilbara iron ore mines. Forrest invested $8 million to become a 47% shareholder in the company. By 2013, his investment had increased by about 500 times in value, and his net worth was round $4 billion.

In 2003, however, Forrest faced many problems. But he was always an optimist. The main FMG deposit was around 300 kilometres south of Port Hedland, where the new port was planned. First, he had to build the mine and the transport infrastructure to get the ore to a new port, then he had to also build the port – and this would take enormous capital.

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When he became CEO in 2003, iron ore was trading at around USD30 per tonne. The economics of the project were thus marginal. It did not help that the ore body was inferior in quality to the ore bodies being mined by Rio and BHP in the Pilbara. Even if he could get the ore to port, it was unsure if any buyer would want it, as the world was oversupplied with good quality iron ores at low prices.

FMG spent $170 million drilling 9,000 holes between late 2003 and 2005 to confirm the size and quality of its deposit. The news was good – the company had found massive iron ore deposits - and coincided with a move upwards in the world price of iron ore. Forrest set a target to commence exports in 2006. While Fortescue did not in fact commence exporting until 2008, when it finally did, prices were moving up strongly and FMG was in a position to deliver large volumes of ore to the voracious Chinese market.

Forrest initially approached Rio and BHP to use their rail lines and ports, but he was rebuffed. Many in the Perth business establishment were dismissive of Forrest – many even named him Twiggy (a ‘twig’ is the smallest part of a ‘forest’), which was a nickname that stuck. Forrest was, however, determined to make a success of FMG, so he decided to go it alone in developing new rail and port infrastructure for the new mines.

Between early 2005 and mid-2008, FMG spent around $2 billion developing the necessary logistics infrastructure to get its ores to port. All the while, FMG’s geologists were exploring the Pilbara, and the company soon emerged as the largest tenement holder in the region – at a time when soaring prices were transforming the economics for previously unprofitable ore deposits. In July 2007, the company raised around $500 million in new equity, all the while borrowing as much as it could from bondholders.

By 2013, FMG has emerged as a significant second tier iron ore producer. It anticipates shipping 180 million tonnes in 2014, up from 80 million tonnes in 2013. As much of its infrastructure is new, its average costs of production (which stood at around USD 35 per tonne in late 2013) should continue to decline as mines develop and customer relationships emerge.

A Global Major - Rio Tinto

Rio Tinto is the world’s second largest producer of iron ore, and just ahead of BHP in terms of the production of iron ore in Australia (BHP also has significant iron ore operations in Brazil).

The geographic focus of its production is Western Australia, and more specifically the Pilbara region of Western Australia, which is around 1500 kilometres north of the State capital, Perth. The Pilbara is a dry and unforgiving region. The red earth is given its colour by the iron oxides in the ground – the best of which form the important iron ores that Rio mines and exports.

Over decades, Rio Tinto has spent billions of dollars developing logistics infrastructure in the Pilbara region to allow it to mine, transport and load iron ore onto ships bound for markets, predominantly in Asia. This infrastructure includes mine infrastructure, processing capacity at mine sites, living quarters, rail and loading infrastructure and port facilities.

Rio exports most of its iron ore through two ports on the Pilbara coast – at Karratha and Dampier. BHP and Fortescue’s main ports are around 200 kilometres further north east, at Port Hedland. Rio

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also maintains an extensive network of railway lines – some 1500 kilometres – in the Pilbara region, linking its mines with its port facilities.

Table 7: Rio’s Pilbara Capital Investment Projects Reported in the 2012 Annual Report

Expansion of the Pilbara mines, ports and railways from 237Mt/a to 290Mt/a. Rio Tinto’s share of total approved capex is $8.4 bn.

$9.8bn Completion of the phase one expansion to 290Mt/a has been brought forward to the third quarter of 2013. Dredging and piling at Cape Lambert is complete.

Expansion of the Pilbara port and rail capacity to 360Mt/a. Rio Tinto’s share of total approved capex is $3.5 bn.

$5.9bn The phase two expansion to 360Mt/a is expected to come onstream in the first half of 2015. This includes the port and rail elements which are now fully approved and an investment in autonomous trains. The key component of the project still requiring approval is further mine production capacity.

Development of Hope Downs 4 mine in the Pilbara (Rio Tinto 50%) to sustain production at 237Mt/a.

$2.1bn Approved in August 2010, first production is expected in 2013. The new mine is anticipated to have a capacity of 15Mt/a and a capital cost of $1.6 billion (Rio Tinto share $0.8 billion). Rio Tinto is funding the $0.5 billion for the rail spur, rolling stock and power infrastructure.

Phase two of the Marandoo mine expansion in the Pilbara to sustain production at 237Mt/a.

$1.1bn Approved in February 2011, the mine will extend Marandoo at 15Mt/a by 16 years to 2030.

Investment to extend the life of the Yandicoogina mine in the Pilbara to 2021 and expand its nameplate capacity from 52Mt/a to 56Mt/a.

$1.7bn Approved in June 2012, the investment includes a wet processing plant to maintain product specification levels and provide a platform for future potential expansion.

The capital costs involved in Rio’s Pilbara iron ore activities are notable (refer Table X). As Rio’s operations spread further south and east away from its ports, the costs involved in new infrastructure increases. It is estimated that the Yandicoogina mine, approximately 200 kilometres east of Rio’s first mine at Tom Price, will eventually require capital investments exceeding $1.7 billion to produce 4 million tonnes per annum of exportable ores.

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Table 8: Rio Tinto Iron Ore Reserves – Proved and Probable – 2012

Proved Ore 2012 Probable Ore 2012 Rio Tinto share

Million tonnes

% Fe Million tonnes

% Fe Share (%)

Million tonnes

Reserves at operating mines

Hamersley Iron (Australia) – Brockman 2 18 62.9 26 61.4 100 44– Brockman 4 422 62.3 139 61.3 100 561– Marandoo 188 63.5 23 61.2 100 211– Mt Tom Price 16 64 44 63.4 100 60– Mt Tom Price 10 61.1 1 59 100 11– Nammuldi 74 62.8 92 62.4 100 166– Paraburdoo 6 62.9 7 63.9 100 13– Western Turner Syncline 262 62.3 74 61 100 336– Yandicoogina 209 58.6 0.4 56.9 100 209– Yandicoogina (Process Product) 115 58.6 100 115Channar JV (Australia) 24 63.1 18 62.7 60 25Eastern Range JV (Australia) 40 62.7 9 62.7 54 27Hope Downs JV (Australia) 9 61.3 241 61.6 50 125– Hope Downs 4 (Brockman ore) 76 62.9 55 63.3 50 65Iron Ore Company of Canada 320 65 235 65 58.7 326Palabora (South Africa) (t) 7.4 55.1 57.7 4Robe River JV (Australia) – Pannawonica 175 57.3 99 57 53 145– West Angelas 161 62.2 67 60.9 53 121Total @ Producing Mines 2125 1138 2,564

Reserves at development projects Silvergrass East 61 62.7 38 61.3 100 99Simandou (Guinea) 1,844 65.5 50.4 928Turee Central (Australia) 72 62 6.1 61.4 100 78Total @ Development Projects 133 1888 1105 Rio Tinto Total Ore Reserves 2258 62.0 3026 61.4 3669

Source: Rio Tinto Annual Report, 2012

Interestingly, Rio’s largest single potential mine is at the Simandou deposit in eastern Guinea, western Africa. The Simandou Ranges, where the deposit is located, are part of the Guinean forest ecosystem of West Africa, which ecologists suggest is one of richest and most diverse ecosystems on Earth.

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Hundreds of millions of years ago, before the modern continents of South America and Africa formed, this deposit was geographically close to Vale’s massive deposits in the State of Para in Brazil as part of the Gondwana supercontinent and probably formed at the bed of the same inland sea.

To date, Rio has not made major investments in Guinea. The mine will require a 650 km railway to from the mine to the coast at Matakong to allow for exports, primarily to China. If all goes to plan, exports should commence in 2016, but plans like these, given the complexity of the project, could be optimistic.

Summary

Australia is often termed ‘The Lucky Country’. It is indeed to have massive, high quality iron ore reserves, especially in the Pilbara region. However, for many years, this ore was priced at little more than it cost to mine and transport, and the business was poor.

The transformation of Asia, and especially China, changed all that over the space of three years. Between 2007 and 2010, prices more than trebled, and the massive mines and deposits owned by the two iron ore majors – Rio and BHP – began making their owners billions of dollars every month.

The growth was not without challenges. Extracting more and more ore required more and more capital investment. A key question – would prices stay high? Another question – would upstream partners in Asia contribute capital in exchange for guaranteed capacity of ores at lower prices? A third question – would new entrants, dazzled by the profits being made, flood into the industry, driving down prices and cutting the profits of the majors.

By late 2013, some answers had emerged. The ore price would fall from its 2010 highs, but it would remain comfortably above USD100 per tonne – a price well above production costs for the established Pilbara producers, and for the emerging firm Fortescue.

Asia’s steel mills would continue to join with established and emerging miners to bring on line new production. Indeed, there seemed a strong intention to create new miners in Australia to break the strangehold on the market by Rio and BHP – evidenced by partnerships with medium and smaller firms like Clive Palmer’s Mineralogy, Gindalbie Metals in WA’s central region and the emerging miner Western Desert Resources, in Australia’s Northern Territory.

New entrants had emerged, but their path to production was often troubled. Miners extracting ores with lower Fe levels required beneficiation processes prior to export – and this was sometimes technically complex, expensive and innately risky. Miners with small, high Fe deposits in the Pilbara found it hard to get access to transport and port facilities. Small miners away from the Pilbara often needed to start from scratch in terms of infrastructure – never an easy task.

The industry is still attractive. In 2012, Rio and BHP, between them, made almost $500 million per week from iron ore – almost all from their Pilbara mines. Mining and transporting their ores to port costs the majors around USD 50 per tonne, while at the time of writing prices were around 3 times that. If future profits of only USD 50 per tonne are achieved, Rio’s Pilbara mines alone could deliver $100 billion in future profits over their lifetime.

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Still, a winner’s curse scenario might be brewing. Prior to 2003, iron ore prices were far less than the current costs of production in the Pilbara. Should Asia’s growth slow, demand for steel could fall steeply, with prices for iron ore following suit. A lower carbon future for the world will also make recycled steel more attractive – to the detriment of steel produced from iron ore.

In such a scenario, much of the capital assembled in the Pilbara could be gathering dust in the years to come, rather poetically returning to the rust from whence it came.

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i Beneficiation – iron ores that are magnetite-based are magnetic, and the beneficiation of these ores generally requires grinding the ores to a tiny size such that the silicates (sand) and iron oxides can be separated by passing the blend under a magnetic separator.

Hematite beneficiation is a little more complex. As hematite is not magnetic, the ore is crushed and passed through a bath containing water and bentonite (or other heavy and soluble elements). This makes the solution’s density (or specific gravity) between the density of hematite (which is heavy) and silicate (or sand, which is relatively light). In this process, the silicates float, and the hematite sinks, and is thus able to be collected from the bottom of the bath.

Large scale beneficiation plants are very costly, and can run into hundreds of millions of dollars of capital costs and significant ongoing running costs without greatly adding to the value of the ore.ii http://www.businessspectator.com.au/news/2013/12/6/china/china-sabre-rattling-iron-ore-price-fmg-chiefiii http://www.worldsteel.org/statistics/crude-steel-production.html

iv http://www.abc.net.au/news/2013-10-30/are-train-drivers-in-the-pilbara-the-highest-paid-in-the-world/5029012v The Chinese scientist Du Shi first developed blast furnace technology around the year AD 31, more than a thousand years before it was ‘invented’ in Europe!