KGB: Neville Power

The Fortescue chief says mining companies won't pay as much under the MRRT as the government expects, while the company's cash costs are set to fall and its funding package is coming together well.

Fortescue Metals Group chief executive officer Neville Power tells Business Spectator's Stephen Bartholomeusz:

- Mining companies will not pay the level of tax the government expects under the MRRT.

- The diesel fuel rebate is not a subsidy for miners, and scrapping it would impact Fortescue significantly.

- Fortescue's overall cash costs will fall by around $10 a tonne as production in the Chichesters ramps up.

- A fall in Chinese GDP to Beijing's targeted 7.5 per cent would still mean significant demand growth for steel and iron ore.

- The company is keeping all options open on its ports strategy.

- Fortescue's funding package is coming together well, and there remains ample scope in the future to tap markets for further funding should new projects be announced.

Stephen Bartholomeusz: Nev, I see you’ve already grabbed some headlines recently and the challenge to the MRRT is going ahead?

Neville Power: Yes, Stephen. The MRRT from Fortescue’s point of view is a very inefficient, ill conceived of tax and we intend to challenge it. We believe there are good grounds to challenge it under the Constitution and we intend to launch that challenge once we’ve finished our legal briefings.

SB: If that tax is implemented, would Fortescue have a significant liability and if you would, do you have any idea of its magnitude?

NP: Under the current drafting of the legislation, although it’s very complex, we would not have a significant liability under the tax, however it does have a very high compliance cost that goes along with it. Our concern though is that it won’t raise the funds that the government expects it to raise and therefore it will be changed and modified on the run and we’ll end up with an even worse result which impacts the industry and affects mining investment long term.

SB: When you say you don’t think it will raise as much money as the government said it would raise I think there’s a view that because of what’s happened to prices and the dollar since that tax was designed, it’s almost by definition it’s going to raise less. Was that the way you’d look at it?

NP: Yes. That’s exactly right. And in addition to that, the tax allows for the deduction of the existing assets, so mines that have existing production assets can claim that as a deduction and reduce their liability under the tax. And I think that while we’ve never seen Treasury modelling on this, it’s clear that the mining companies will not pay a level of tax that the government expects and therefore it’s likely to be modified and meddled with to try and improve that revenue collection and then we’ll end up with an even worse result.

SB: So, the ability to use market value for resources that might have been there for decades, that leads Andrew Forrest to talking about this tax being discriminatory to smaller and newer miners, isn’t it?

NP: Yes. That’s right. What I think Andrew has clearly demonstrated is that there was an alternative which would have been a better result for the industry and a better result for Australia overall. And I must say, Stephen, that Fortescue is not opposed to paying tax per se. We pay our fair share. In fact, this financial year we’ll pay around $1 billion dollars in taxes and royalties and that will rise to around $2 billion dollars next year in income tax and royalty payments. So, it’s not about us being opposed to paying tax, but good taxes should be broad based and they should be efficient and this is neither of those.

SB: As you referred to earlier, there’s been a lot of speculation around it because the MRRT is not going to raise as much money as the government expected. And because they’re facing such a Herculean task to get the budget into surplus they’ll axe the diesel fuel rebate, they might change the treatment of exploration expenditure and overburdens driven to make them capitalise on this. What would be the impact on you if these things occurred?

NP: Well, these would impact us as they would impact the rest of the mining industry and I think the whole problem here is that there is far too much preoccupation with looking at ways to tax the parts of the economy that are performing well and nowhere near enough attention and policy being put to how growth in the economy is being stimulated. So, we’ve got a focus on divvying up the existing pie and trying to tax the economy into prosperity and we all know that that’s not going to work. So, what would be a better result is for the government to focus on how they can stimulate and create an environment where business wants to invest in the economy and create growth and create jobs through that mechanism.

SB: You use a lot of diesel, I imagine, in your operations. Would the bill be very substantial?

NP: Absolutely. Again we haven’t seen any details of this and it’s only a rumoured proposal, but we use around 300 million litres of diesel per annum and that will increase as we expand our operations to 155 million tonnes per annum by June of next year. So, that would impact us significantly. And, Stephen, let me say that the diesel fuel rebate is not a subsidy in any way, shape or form. The whole idea of the excise on diesel was to collect money to build public infrastructure on the basis that that’s where that fuel would be used, in other words, on highway trucks. Now as you’d appreciate, most of our infrastructure is private infrastructure and our diesel is used in rail, power generation and on off highway trucks and equipment in our mining operations where we have to build all of our own infrastructure. So, it’s not about us getting a free kick out of getting back the diesel excise; it is a tax that was put on diesel to fund public infrastructure which we don’t use.

SB: Yeah. In which case it would be fair to say that if the rebate were abolished, in effect it would be a new tax on miners.

NP: That's exactly right, because it would applying a tax which would be grossly unfair. Because as I’ve said the whole idea of the excise was to fund public infrastructure where that diesel was being used.

SB: Are you impacted by the carbon tax? It just seems there’s a plethora of taxes coming in your direction.

NP: Well, thankfully we’re not significantly impacted by the carbon tax, Stephen. But I think the carbon tax is one of those taxes that have a lot of unintended consequences and our concern is that again it’s one of these taxes that just kills investment and starts to deter business from making investment and creating growth and that’s the last thing we need in the Australian economy right now. What we need is we need an environment that encourages business to invest and encourages people to develop new businesses and particularly service businesses around the economy.

SB: Yes. Both the MRRT and income taxes are going to be great for accountants, though.

NP: Well, they’re very complex and in the case of the MRRT it’s another whole set of accounts that we’re having to develop. And so we’ve got a significant amount of people focused on trying to get the accounts ready for this tax when it comes into effect from the 1st of July. So it’s a very inefficient tax in that sense that the compliance costs are very high and I am sure that there are hundreds of people that are being employed on the government’s side as well, so again we see a lot of the tax revenue will be burned off through that inefficiency.

SB: Let’s talk a little bit about Fortescue itself. In your latest quarterly reports, volumes were down and prices were down a little bit. I think because you had heavy rains and floods; cyclones. But you still appear confident that you’re going to be able to produce that 55 million tonnes this year. What’s more important to you at this point? Is it price or volume?

NP: Oh well, both are important, Stephen, but let me say we were significantly impacted by the two cyclones, but also the heavy rain that was associated with them and that pulled down our production, but it was against the backdrop of a record production in December. And with the wet season pretty much at an end now, we are well positioned to have a strong quarter in the June quarter and to achieve our 55 million tonnes. So we’re very confident of being able to do that. In terms of price, the price ended the quarter at the index price of about a $150 per tonne, which is very strong, and we’re very happy with where that’s at – and we certainly don’t see any change to that going forward. Our net realised price over the quarter was a $126 a dry tonne, which was an improvement over the December quarter, and we would expect to see that improve in the June quarter as well. So, we’ll have strong volumes and a continuing strong price in the June quarter.

SB: Your cash costs are something below $50 a tonne, aren’t they?

NP: Year to date we’re around $49 – a bit over $49 dollars a tonne. Again this quarter, this March quarter was above $50 a tonne because of the impact of volume from the rain, but also a very high Australian dollar. It was $US1.06 average for the quarter compared with $1.01 for the December quarter last year. And also we had a slightly increased strip ratio. Again, we’ll see that cash cost come down over the next quarter with our volumes returning to normal and we’ll end the year in the guidance range of $45-$50 dollars a tonne.

SB: You’re in a midst of a massive expansion program towards a 150 million tonnes per annum by the middle of next year. Will your costs move up as you produce the extra volumes or do you expect them to hold around about the levels they are today?

NP: Stephen, we’ve got a significant structural benefit in that when we bring the new Solomon mine on stream next year, that’s an additional 60 million tonnes to add to the 95 million tonnes that we’ll produce from the Chichesters. The Chichesters are a relatively high strip ratio at about 4.4 to one, but the Solomon mine is less than two to one, so we have an ideal situation where the new production that we’re bringing on stream is in fact lower cost than our existing production. So, overall our cash costs will come down across the 155 million tonnes by about $10 dollars a tonne.

SB: So, that means that if one looks forward into the long term future, in a sense price is far less relevant to you than volume because it is a low cost business?

NP: We are a low cost business and we would expect as more seaborne supply comes onto the market that it will replace higher costs and therefore it is a major focus of ours to make sure that we maintain ourselves low on the cost curve, so that we are bulletproof going forward. Again, I don’t see any major change to the iron ore pricing in the next year or two because there isn’t any major change in the supply or demand balance that’s going to cause that.

SB: There is a view out there though, isn’t there, that somewhere around about 2015, ’16, ’17, the market comes into balance?

NP: Yes, I think that’s right. And it does depend over that period of time just what the cost base does because there is a lot of production out there that is exposed to increasing labour costs and increasing energy costs, and particularly in China. So a lot of the domestic Chinese production which has got high labour input and high energy because of the type of iron ore it is will be exposed to higher costs. So, by the time we get to 2016, 2017 I suspect that the cost curve will have lifted up again.

SB: Even in Australia that’s happening already too, isn’t it? I mean everyone in the sector is complaining about cost pressures, whether it’s labour or whether it’s equipment. You’ve got this massive $10 billion dollar capex program running, but apparently it’s on budget and ahead of schedule, so aren’t you experiencing those pressures?

NP: Yes, we are, Stephen, but it tends to be in specific trades and come into specific areas, so there are some professions and some trades which are quite difficult to get a hold of. But look, I think the inflation numbers that we’re talking about in terms of labour inflation are in the single digits. You know, we’re talking in the 6 per cent to 7 per cent range. We’re not talking double digits. So, while it is impacting us and increasing costs, it’s not by any means out of control and we’re being quite successful in recruiting people across from the east coast -- where unfortunately business over there is not doing so well and there are a lot of people looking to either relocate or fly across from the east coast to work here, so we are trying to tap into those labour pools.

SB: That’s actually one of the surprising things, I suppose, about the employment numbers -- that the mobility of the workforce was underestimated and that people like you are actually soaking up the pool.

NP: Yes. Well, I think we’ve seen a significant downturn in manufacturing, particularly in things like steelmaking and in the car plants. And of course it’s an ill wind, Stephen, but we are able to tap into those labour pools and provide those people with an alternative. And we have just, for example, commissioned our airstrip at the Solomon mine and we’re in the process of building one at Christmas Creek, which will allow us to fly direct flights in from the east coast. So we will have the flexibility to bring people from the east coast as well as from Perth and Western Australia.

SB: There is some resistance from the unions to that FIFO approach, but it’s kind of unavoidable for an employer like you.

NP: Stephen, we’re strongly committed to having regionally based residential workforces where we can we do that -- so in towns like Port Hedland, for example, we’ve completely maxed out on the amount of land that we’ve been able to get a hold of there and we’re working with the government to get more land released. So, wherever possible we have our workforces as a residential workforce. Where our mines are located though there is no local workforce, there are no local communities and therefore we have to fly in, fly out from somewhere. So whether it’s from a regional town or whether it’s from Perth or whether it’s from further afield, we still have to have a fly in, fly out workforce because there are simply no communities there and certainly nothing near the numbers of people that we’re employing.

SB: Last week China’s March quarter GDP numbers came out and I think it was 8.1 per cent, heading rapidly towards that 7.5 per cent target they’ve set for themselves this year. Is that disconcerting in any way for you that China seems to be slowing quite rapidly even if it is a controlled slowdown?

NP: Stephen, I think 8.1 per cent or even the target number of 7.5 is a fantastic growth number and I’ll be delighted to see that continuing over the next couple of years. I think it’s prudent that the Chinese government has tried to take a bit of heat out of the economy, particularly out of the housing and property development market because I think they were concerned about an overheat there, so I think it’s a good thing that we’ll get a more sustainable long-term growth. And look, 7.5 to 8.5 per cent will probably translate to a 4 per cent or 5 per cent growth in steel and on the base number that we’re talking about for steel production that will be a very significant increase and translate to strong iron ore demand. So I think all of that is very good news for us.

SB: As part of your expansion plans, you’re going to need more port capacity. Have you decided whether it’s going to be at Anderson Point or if it precedes BHP out of harbour expansion at Port Hedland?

NP: We’re keeping all of our options open, Stephen, and we’re doing a lot of work on that right now, but in the long term Anketell remains a key part of that strategy because longer term we see that a three hub, two port strategy is the right combination of infrastructure for us. We are investigating options at Port Hedland primarily because we have the new deposit that we discovered around eighteen months ago has proven up to be over 2 billion tonnes of high quality iron ore. And that’s forced us to look at options around our existing infrastructure in Port Hedland, but long term we have all of those options at our disposal.

SB: One thing that struck me when I was looking at some of the things you have produced is how rapid and brave the expansion of Fortescue has been, but how big the resource is that you could expand.

NP: Well, that’s right, Stephen, for as much as we’ve grown to date. And we have made a deliberate strategy out of building our infrastructure quickly and then ramping up very rapidly because we want to meet the demand that’s coming from China. But secondly we know that building infrastructure quickly and ramping it up quickly is the cheapest way to do it and that’s one of the key reasons we’ve been able to do it for lower capital intensity than other mining companies. But the second part is that we have been converting our tenement holding into our resource portfolio at around about 1.5 billion tonnes per year of new resource coming into our portfolio. So, we’re working our ground very hard to continue to develop our resource base and develop options for the continued development of our business in the Pilbara going forward.

SB: And presuming that’s part of your response to those recent accusations that Fortescue parks its tenements, you’ve actually been exploiting quite a few of them.

NP: Yes, Stephen. We’ve done anything but park them. We’ve been working very hard. We’ve got record exploration expenditure and, as I say, we’ve been adding them at a rate of about 1.5 billion tonnes to 2 billion tonnes a year in the last couple of years into the resource base. And we’re not stopping there. We want to continue because the Pilbara is relatively underexplored -- because there’s been no reason to explore it in the past -- but we see it as a very prospective area.

SB: A final thing, the rate and scale of expansion that you’ve been undertaking is very cash hungry and big net cash outflows when you take into account the investing you’re doing. You recently went to the debt markets for $1 billion dollars and some way or another came back with $2 billion. Does that complete your funding needs for the current expansion program? And is there a point where you can see the thing generating strong net cash?

NP: Well Stephen, we were delighted with the response that we got from the bond markets and yes we launched at $1 billion and we were five times oversubscribed on that, with very favourable terms. But we had always intended to up-rate that $1 billion dollars if there was a strong response to it, so a part of that is the process that you use in the bond markets to get that going. In terms of that, we are completing other pieces to the funding. We’re looking at export credit agency funding from Europe. We’re looking at lease facilities for some of the mining equipment. So, we’re continuing to put all of the pieces of our funding package in place and that’s coming together very well. With our current production profile, we’ll become net cash positive again early in 2013 and then start generating significant cashflows from that point on. So we’re very happy with where we sit at the moment in terms of our funding.

SB: Provided you don’t push the button on another big expansion?

NP: Well, I think to do that would mean that we’ve got such a phenomenal business case that it stacks up so well that we would easily get that financed in the markets. And we have people coming to see us every day looking to invest in our business and wanting to co-invest on new projects with us, so I think there’s ample opportunity for that.

SB: Nev, thanks very much indeed for your time.

NP: No problem, Stephen. Good talking with you and I look forward to catching up again soon.

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