Alarm bells sound on Rinehart's hill

The price of performance guarantees on mining loans is set to rise, while the cost of owning and operating sites has gone through the roof – none of which augurs well for Gina Rinehart's Roy Hill project.

In theory this should have been a good week for Gina Rinehart's Roy Hill iron ore project. The stock market is clearly recognising that China is turning on the economic booster burners again and in due course that should lift demand for iron ore – good timing for a new iron ore mine.

At the same time the government approved her application for foreign workers at Roy Hill, albeit with controversy.

But a series of unrelated events must be ringing warning bells in the Rinehart camp. Some of those events are ringing similar bells at BHP and Rio Tinto (A mining boom cut-off is coming, May 21).

As it now stands there are scheduled to be many projects undertaken at the same time and unions will not be able play hard ball at all of them. The key for a private group like Rinehart is to keep under the radar. Instead the combination of her family affairs, the Fairfax tangle (The iron in Fairfax's future, May 30), her BRW Rich List status and finally the controversy over the application for foreign workers means that Roy Hill is in danger of being near the top of the union attack list.

The Rinehart group has strong cash flow and cleverly sold the bulk of its Queensland coal assets, so is well placed. But it would seem that in the next six months the Roy Hill project must raise some $7 billion in bank loans, with National Australia Bank and BNP the lead bankers.

The cost of both erecting and operating any new mine has gone through the roof, so the economics are nowhere near as good as when the project was first conceived. And the bankers will want to make sure that there will not be a construction cost blowout in what is a very large project involving a mine, rail line and port. The availability of money also depends on what is happening in Europe.

One danger is that so called "desalination cancer” will creep into the project – a disease named after the Leighton Victorian desalination plant contract where unions controlled much of the site contributing to the big losses. Everyone is frightened of desalination cancer infecting mining construction projects and Rinehart may require the help of the West Australian government (Dodging mining sector mothballs, May 22).

Rinehart and her bankers will want something close to a fixed price contract but that will require the lead constructor gaining extensive bank performance guarantees. It just so happened that NAB, along with the other large banks, lost heavily in giving performance guarantees to Hastie. The price of such performance guarantees is going to rise, if they are available.

If the iron ore being produced at Roy Hill is produced at a cost that is comparable to BHP and Rio Tinto then there is room too move. If the costs are much higher then gaining finance will be tougher because then everyone will be banking on high iron ore prices being sustained.

The simple fact is that the enormous rise in the cost of mining construction in Australia is making everyone look twice at what they agree to undertake.

In this environment, project entrepreneurs must have great faith that the demand curve is going to be high enough to maintain the mineral prices needed to justify the much higher capital and operating costs.

The carbon tax adds an extra dimension of uncertainty, as does the mining tax. And now there is doubt over whether projects will be able to bring in migrant labour and there maybe a tough line taken on the use of Australian materials. All this adds to the cost.

In this environment Rio Tinto has become more interested in coal expansions in Mozambique than in Australian coal. It will expand iron ore but the more ambitious plans may be mothballed in favour of Africa.

BHP has the world’s most valuable mineral deposit at Olympic Dam but must spend four to six years removing overburden to get access to the ore reserves. It would be tempted to defer in the current environment but the South Australian Mining Minister Tom Koutsantonis makes it very clear that if BHP does not go ahead at the end of this year the deposit will be taken off it.

So if SA takes a tough stance BHP will almost certainly proceed with Olympic Dam, perhaps at the slowest possible rate. But that means the Port Hedland outer harbour and Canadian Potash are in jeopardy. Queensland Coal will go to the back burner.

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