China Rethinks Deals for Resources

August 25, 2013, 8:35 p.m. ET

China Rethinks Deals for Resources

CHUIN-WEI YAP

BEIJING—A dusty $8 billion Australian mine that has yet to export a chunk of ore is emblematic of why China is rethinking its huge, multiyear effort to buy up resources abroad. The mine, the Sino Iron project more than 900 miles north of Perth, in Western Australia, was launched in 2006 with an estimated $2.5 billion in development costs. The mine was to supply China with iron ore, a crucial steelmaking ingredient, and help China break into a global mining market dominated by BHP BillitonBHP.AU -0.18%Rio Tinto RIO.AU +0.15% and Vale VALE3.BR -0.39% SA. Instead, Chinese owner Citic Pacific Ltd. 0267.HK +0.67% has grappled with everything from high labor costs and naturally occurring asbestos in the rock to a massive ore-grinding mill that years after its installation still doesn’t work.“These mills are the biggest in the world, and it is not unreasonable to expect that there would be some problems due to their complexity,” said Damian Connelly, director of Perth-based consultancy Mineral Engineering Technical Services. “Had they used conventional gearbox pinion-drive mills, these problems wouldn’t have arisen to the same extent.”

Analysts say the project’s capital expenditure could reach $11 billion. Citic Pacific, an arm of state-owned Citic Group, declined to respond to requests for comment.

China has plowed $226.1 billion into outbound mergers and acquisitions to grab a slice of global resources since 1995, about a quarter of which was in the mining sector, according to data provider Dealogic. But people inside and outside the government say Beijing is taking a more careful look at projects.

“The government still encourages ‘going out,’ ” said Jin Bosong, deputy director of the Ministry of Commerce’s International Trade and Economic Cooperation Research Institute. “But now the emphasis is to make companies ask questions like: ‘Can the project make money?’ ” he said.

Mining projects are high on the list. Last December, a senior official at the government’s top economic-planning agency said at a closed-door conference that while more than $10 billion has been spent on China’s overseas iron-ore mining investments, few of these projects have begun operation, state-run Xinhua news agency reported.

“Some of these projects’ infrastructure costs are far higher than the investment cost for the iron ore itself,” said Wang Jianjun, deputy head of the National Development and Reform Commission’s overseas investment department, according to Xinhua.

Also in December, state-owned Metallurgical Corp. of China pulled its $3 billion magnetite project at Cape Lambert in Western Australia, blaming chronic cost overruns. A year earlier, state-owned Sinosteel Midwest Corp. shelved its $2 billion Weld Range project, in the same region, because of a lack of infrastructure to move the ore.

Wuhan Iron & Steel Group 600005.SH -0.44% last November suspended a $5 billion joint venture signed in 2009 to build a steel plant in Brazil, blaming the need to build rail infrastructure for the greenfield site. “We’re not moving on it because it doesn’t have much infrastructure,” Chairman Deng Qilin said.

Beijing’s barrage of iron-ore asset purchases in the last decade has yielded little. Ore imports from China-controlled global mines currently account for just 2.7% of the country’s total iron-ore imports, far below an official target of 40% set in 2011, according to data from Antaike, a Beijing-based consultancy, in June.

Mr. Wang as well as officials of the state-backed industry group China Iron and Steel Association, or CISA, say the problems don’t mean Beijing will stop China’s overseas push for global ore assets, underlining the country’s need to “break a global monopoly.” “Citic is a special case, where there was a failure to properly grasp local laws and practices, and there were a lot of changes in the investment conditions,” said CISA’s deputy secretary-general, Chi Jingdong.

Citic Pacific’s Sino Iron project was expected to produce 24 million metric tons of magnetite concentrate a year when completed. The project, the world’s largest magnetite iron-ore mine according to Citic Pacific, is based in Cape Preston, a rust-red promontory so remote that the U.S. National Aeronautics and Space Administration uses the area to simulate the terrain of Mars.

Citic Pacific in its filings acknowledged the cost blowout and blamed a variety of causes, including the lack of technicians. The labor deficit was compounded by Australian laws limiting the import of Chinese workers. Citic would have faced an additional $50,000 to $80,000 per overseas worker for visa and relocation, said Jody Elliott, co-founder of the Resource Channel recruitment specialists based in Perth.

The company doesn’t break out labor costs, but government data show Australian mining wages increased 40% in the past seven years, surpassing all other parts of its economy.

Toxic asbestos discovered on the site added to Citic’s environmental worries, said Mick Buchan, secretary of the Construction, Forestry, Mining and Energy Union, which has provided services to some workers at the site but doesn’t represent them. Citic said it has a plan to minimize workers’ exposure to the fibrous mineral, which it said is “a concern for almost all mines in the Pilbara region.”

Paul Vogel, chairman of Western Australia’s Environmental Protection Authority, said such asbestos discoveries are “not uncommon” in the Pilbara and it could cost Citic “in the lower millions [of dollars]” to clean it up.

Magnetite, the kind of iron ore produced at the project and one that burns better in steel furnaces, can be almost twice as expensive to process as hematite blends. “Magnetite projects are very high in capital costs,” Mineral Engineering’s Mr. Connelly said.

Then there is the nonfunctioning mill, a steel cylinder 40 feet in diameter. One of 12 similar machines, the cylinder was a centerpiece of the iron-ore mine. The company called them “the world’s largest mills.” It attributed the breakdown to a damaged stationary part of the mill.

Independent engineering experts estimate the mills cost $46 million apiece. Experts say repairs are likely to take three months.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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