Fortescue rakes up the funding scraps

The moment seems to have passed for new miners to source blank cheques from investors as even the highly levereged Fortescue Metals is preaching prudence.

Fortescue Metals’ success in raising another $US1.5 billion of debt funding while simultaneously warning that junior miners will struggle to raise capital in the current climate provides a nice illustration of the tipping point in the resources cycle.

Twiggy Forrest was among the earliest of the mining hopefuls to recognise the implications of China’s growth for commodities, particularly iron ore, and over the past nine years has been engaged in a frenetic debt-funded scramble to secure Fortescue’s place within the sector.

At this moment the group is in the midst of a $US9 billion expansion program to lift its iron ore production from 55 million tonnes per annum to 155 million tonnes by the middle of next year. The latest borrowings were to cover a $US600 million blow-out in the capital costs of the expansion and to help fund the remaining $US6.2 billion of spending remaining.

Because Fortescue was an early mover as the resources boom got underway it has, relative to other new miners, quite low production costs. While it is a high-cost producer relative to Rio Tinto and BHP Billiton, whose Pilbara operations produce ore at cash costs below $US30 a tonne, Fortescue’s $US46 or so a tonne leaves plenty of margin to service its debts while the iron ore price is around $US130 a tonne.

The steep fall in iron ore prices from closer to $US200 a tonne at their peak last year to their current levels – and similar falls in other key commodities – at a time when construction and operating costs in Australia have been rocketing, however, means that times are a lot tougher for the later entrants into the sector.

Many of the billions of dollars invested in developing the mid-west region of Western Australia – which was targeted by Chinese entities at the height of the super-cycle in commodity prices, anxious to develop a new force in iron ore to discipline Rio, BHP and Vale – now looks likely to be stranded.

The region needs new $US6 billion-plus rail and port infrastructure to be developed but delays and cost blow-outs have cast a very large question mark over its future.

It isn’t only the mid-west hopefuls that are facing a question mark over their future. There are a lot of other projects sponsored by junior or mid-tier miners in WA, Queensland and elsewhere that are now caught in the pre-development or mid-development phases and which need continuing access to capital that may no longer be available.

The surge in costs even as prices have slumped, along with the uncertainty about the outlook for the global economy and the straightened condition of many of the global banks make new financing for new projects problematic, particularly as the entire sector is facing earnings downgrades as a result of the slump in prices. That’s not conducive to raising either new debt or equity.

Certainly the lower-quality and higher-cost projects may have missed the moment Fortescue grabbed when a big shortfall in supply created a super-cycle spike in commodity prices.

With China’s economy and demand for commodities slowing and new supply coming into the market, the market is in far better balance and the focus of the major miners has shifted from price to volume in recognition that their margins in future will be considerably lower than they were at the peak of the boom.

It says something about the more sombre outlook for the sector that Fortescue, notable for its aggression and optimism, is now talking about consolidating and paying down debt once its latest expansion program ends next year rather than launching another big debt-funded spending spree to increase production further.

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