An iron ore reawakening

An acceleration of deals in the iron ore sector gives hope to a large number of small stocks.

Summary: A falling iron ore price should be putting smaller stocks in the sector to sleep. But a series of events are having the opposite effect, including the $1.4 billion takeover bid launched for Aquila Resources by rail group Aurizon and Chinese steelmaker Baosteel.
Key take-out: The unleashing of fresh interest by China in the Australian iron ore sector, and the prospect of new infrastructure projects in the Pilbara and other regions, is helping to reawaken junior iron ore miners.
Key beneficiaries: General investors. Category: Shares.

It’s raining deals in Australia’s iron ore sector, with the joint $1.4 billion bid by Aurizon and China’s Baosteel for Aquila Resources just one development that could benefit a number of smaller companies currently unable to gain access to all-important rail and port services.

If successful, the Baosteel/Aurizon bid will see a new port built at Anketell Point adjacent to Rio Tinto’s operation at Cape Lambert on Western Australia’s Pilbara coast.

The potential for this to happen was first flagged by Eureka Report two weeks ago (Juniors await iron ore express, April 23) when Aquila was named as one of the potential beneficiaries of the dramatic changes underway in Australia’s biggest export industry – despite a recent fall in the iron ore price and forecasts of lower prices in future years.

Other explorers and miners poised to win from what is a remarkable turn of events include Atlas Iron, Brockman Mining, BC Iron, Iron Ore Holdings, Gindalbie and Mt Gibson Mining.

But the company that best illustrates the reawakening which is occurring is one not mentioned in that April 23 story.

Red Hill Iron is a low-key explorer with well-connected management and it could be a big winner from the push to accelerate planned infrastructure projects such as Anketell Point.

Thinly traded, Red Hill enjoyed a 25% share price rise on Monday thanks to its indirect ownership of ore that might be mined in what’s called the West Pilbara Iron Ore project, the slow-moving development controlled by Aquila which Baosteel and Aurizon want to hurry up.

Red Hill’s price rise from 80 cents to $1 is, however, just one measure of the revived interest in the stock. On the market yesterday the quotes were: bid $1.11, ask $1.80, a spread which indicated that there was at least another 11% of uplift in the stock (and that occurred this morning when a sale occurred at $1.11). But there is perhaps even more upside if potential buyers and sellers meet at the mid-point of $1.45.

Cracking the iron ore oligopoly

Graph for An iron ore reawakening

The speculative Red Hill situation is likely to be repeated as other infrastructure projects alter the shape of the Pilbara iron ore sector. The ultimate aim of Chinese companies is to crack the oligopoly of BHP Billiton, Rio Tinto and Fortescue Metals by encouraging more producers, which could help drive down the price they pay for iron ore.

It is a complex set of circumstances and impossible at this early stage to identify winners and losers. But it is significant that so many deals are being unveiled at precisely the time they were not expected because of the recent fall in the iron ore price from more than $US120 a tonne to around $US105/t.

Since talk of developing Anketell has resurfaced after four years on the sidelines (and despite the lower iron ore price) a series of other events have breathed life into a sector bogged down by a lack of infrastructure and hobbled by legal disputes.

Those events include:

  • A major, and perhaps final, win for the Wright and Bennett families in their dispute with Australia’s richest person, Gina Rinehart, over the mothballed (but massive) Rhodes Ridge iron ore deposit that is half-owned by Rio Tinto. With ownership effectively settled, the way is clear for the 5.3 billion tonne Rhodes Ridge ore deposit to become one of the world’s biggest iron ore mines, and for the Wright and Bennett families to replicate the fortune of Rinehart.
  • Rinehart starting mining operations at her 70% owned Roy Hill mine with its associated infrastructure, and the possible offer of access to the project’s rail and port services to smaller miners along the route to Port Hedland.
  • Citic Pacific, one of China’s biggest companies, considering an invitation to build the mothballed Oakajee rail and port system in WA’s Murchison district. The deal has a full Chinese Government blessing because it will help another Chinese company, Ansteel, extricate itself from a loss-making position in the troubled Gindalbie Resources and its Karara mine.
  • The near-certain delay of a rival to Australia’s iron ore sector, with Rio Tinto launching a vicious legal attack on Vale of Brazil over the Simandou project in Guinea. The fact that Rio Tinto’s allegations of theft against Vale have been made in the US, under that country’s draconian Racketeer Influence and Corrupt Organisation (RICO) laws, means the claim must be fiercely defended by Vale. The legal action might provide Rio Tinto with a convenient way to shift Simandou further back in its project-development pipeline, especially as it has a fresh Australian option emerging at Rhodes Ridge.

Competing forces in play

For anyone with an interest in the Australian iron ore industry, there are competing forces which need to be factored into any investment decisions.

The first factor to consider is that in the short term it is likely the iron ore price will continue to fall, denting the immediate profit potential of companies in production. That’s why some investment banks continue to warn about a correction in share prices.

The second factor is the obvious unleashing of fresh interest by China in the Australian iron ore sector. Plans being laid for a massive increase in direct investment will take years to plan and execute, with expanded production unlikely to hit the market until after 2020.

To put numbers alongside the corporate events of the past month, it is likely that the port and rail projects being planned by China’s Baosteel (Anketell) and Citic Pacific (Oakajee) will cost around $6 billion each.

The Rhodes Ridge mine will be “plumbed” into Rio Tinto’s existing rail and port facilities but could still cost around $5 billion to develop, a small cost given its minimum 40-year life and $500 billion (half-a-trillion dollars) worth of ore in the ground.

The key to everything is not the availability of iron ore resources. It is the provision of infrastructure and workable joint ventures, with both of those issues moving tantalisingly closer to resolution.

The Anketell deal between China’s biggest steelmaker (Baosteel) and a big Australian railway specialist (Aurizon) is a pointer to how the infrastructure puzzle, which has been a major hurdle in iron ore for decades, might finally be resolved and open the way for multiple new mines.

Balancing the short-term and long-term forces will require a degree of dexterity on the part of investors, but the critical factor is that the iron ore industry is waking just as many people thought it was going to sleep. Red Hill Iron is an example of what can happen when the alarm clock rings.

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