New joint venture makes increasing sense for Fortescue

Twiggy Forrest obviously missed Kevin Rudd's announcement that the mining boom is over. His Fortescue group has just done a deal that shows Asian groups are still thinking hard about how to service big rises in demand.

In June last year Fortescue flicked two iron ore deposits that sit about 100 kilometres south of Port Hedland into a new company jointly owned with the Chinese steel-making company Baosteel.

The first deposit, North Star, was 100 per cent owned by Fortescue ahead of the deal, and is a large magnetite ore body with a small oxidised hematite "cherry on the top". The second deposit, Glacier Valley, was owned 65 per cent by Fortescue and 35 per cent by Baosteel, and is 100 per cent magnetite.

Fortescue and Baosteel took stakes of 88 per cent and 12 per cent in the new company, Iron Bridge. Magnetite requires processing to bring it up to usable grades and has taken a back seat to hematite in the iron ore boom, but iron ore was priced at $US133 a tonne when the deal was done, and a float of Iron Bridge was considered likely.

By September, however, iron ore was down to $US86.70 a tonne. Fortescue was locked in debt negotiations and looking at asset sales, and Iron Bridge was on the list.

The price was back up to $US145 by the end of the year, however. It has defied predictions of another slide this year, and was up 28 per cent since the end of May at $US141.20 on Friday, when Fortescue chairman Forrest and chief executive Nev Power announced that Iron Bridge would form a new joint venture with Formosa Plastics Group.

Formosa Plastics is a diversified Taiwanese industrial firm, with shareholders equity of $US61.2 billion and pre-tax profits of $US1.5 billion last year. It is building a Vietnamese steel mill that could in time become the largest single-site producer in the world at 22 million tonnes a year, and is buying into Iron Bridge because it wants to secure iron ore supplies from 2015 onwards.

Formosa Plastics will pay $US123 million for a 31 per cent stake in a joint venture with Iron Bridge covering the twin resources, and commit $US527 million to their development. This is more than enough money to fund a $US340 million plan to initially mine the hematite "cherry" at North Star, process it to roughly double its grade to 66 per cent, and truck it to Fortescue's port facility 100 kilometres to the north at Port Hedland. Fortescue says that production should begin in 2015.

The hematite accounts for only about 1.6 per cent of Iron Bridge's iron ore reserves of 5.2 billion tonnes, however. Magnetite ore that needs to be magnetically treated to more than double its grade to 68 per cent makes up the balance, and the joint venture will investigate a potential 9.5 million tonnes a year second-stage development.

Power's estimate is that the second stage of the project would cost $1.5 billion. If its gets the go-ahead, the $187 million balance of the Taiwan group's initial capital expenditure contribution would go towards it, and Fortescue and Baosteel would stump up another $1.05 billion, in proportion with their 88 per cent/12 per cent ownership of Iron Bridge. Contributions after that would split 69 per cent Iron Bridge, 31 per cent Formosa Plastics, in line with the equity in the joint venture.

Fortescue's 88 per cent ownership of Iron Bridge gives it the biggest funding exposure. Power says that if stage two does get the green light, it will do so on the basis of project funding that is not carried on the balance sheet of Fortescue itself.

There's two kickers to the deal that make it much more attractive for the Australian company. Firstly, Formosa Plastics has agreed to purchase up to 3 million tonnes of iron ore a year at market prices after the first of up to six blast furnaces at its Vietnam steel mill comes on line - in 2015, if the development stays on schedule. Secondly, and very importantly for Fortescue, the Taiwanese group has also agreed to pay Fortescue $500 million upfront to gain access to Fortescue's iron ore export slots at Port Hedland.

The exact value of that deal depends on the fine print. How much export volume Formosa Plastics has locked in at Port Hedland and for how long, in particular. It does underline, however, why Powers is adamant that while Fortescue continues to consider the option of selling a minority stake in its infrastructure network for about $3 billion, it will only take it up if the price is right. The $500 million payment from Formosa Plastics will pay down debt, strengthening his resolve.

More generally, the deal underlines the fact that iron ore and other commodity prices are still underpinned by what by historical standards is very solid demand.

There is an asterisk on the iron ore price right now because Chinese steel mills run down inventories about this time of the year. Rising iron ore production is a longer-term iron ore price suppressant.

BHP Billiton boss Andrew Mackenzie noted recently, however, that global steel consumption was likely to rise by 50 per cent in the next decade, with Asian mills accounting for half the gain. BHP and Rio Tinto can make very good money in that environment. Quality magnetite projects that are within reach of ports can make money too.

The Maiden family owns BHP shares.

mmaiden@fairfaxmedia.com.au