Why Rinehart's empire will survive the iron ore slump

Gina Rinehart’s banner investment, the Roy Hill mine, will be dealt a significant blow if the fall in the iron ore price continues into next year and beyond. But although Gina Rinehart’s wealth will decline sharply -- especially if the iron ore price falls further -- her empire will survive.

At this point, the $3 billion to $4bn that Rinehart and her partners have invested in the equity in the Roy Hill mine is worth much less than its cost. The mine is due to start production late next year.  

As they see the iron ore price fall, some of the non-recourse lenders to the Roy Hill project will naturally be twitchy. In a KGB interview with Fortescue chief executive Nev Power, to be published later today, he declined to comment on the Roy Hill situation in detail. But he expressed sympathy for Rinehart’s task in launching a mine in a tough market.

Power knows just how hard it is to start a new mine.  

Two or three years ago, survival was a real issue for Fortesecue until the company increased its output, lowered its costs and reduced its debt. Power equated Rinehart’s challenge in launching her mine with the trials that Fortescue went through in the early days.

Let me explain how difficult it is to launch a new mine like Roy Hill in tough times. 

Rinehart has put a large amount of her financial wealth on the line to get Roy Hill off the ground, but I must emphasise that the whole Hancock house has not been put at risk. However, in the debt negotiations, the Australian banks and their global partners played hardball with Rinehart and demanded more equity than she really wanted to put at stake. There was considerable brinkmanship, and the banks won. By contrast, when Andrew Forrest started Fortescue, he had much less equity, so Fortescue was much more highly borrowed and therefore more vulnerable than Roy Hill.  

Rinehart also has another advantage. Fortescue was built at a time when vast sums were being spent on the LNG projects, so building costs were much higher. On a comparable basis, Gina Rinehart will be able to build Roy Hill at a far lower cost than Forrest was able to build the Fortescue network.

Rinehart’s Hancock Prospecting has 70 per cent of the Roy Hill project but she was able to sell around 12.5 per cent to Korean steelmaker POSCO for an inflated $1.5bn dollars. Japan’s Marubeni Corporation and Taiwan's China Steel Corporation are also partners, which lessens her exposure. But that is the good side of Roy Hill for Rinehart; Power knows all too well the hard side.  

When you start a mine, your initial output is always well below capacity and operating costs per tonne are high. At a time when the iron ore price is falling, these high costs are likely to run the new mine into larger than expected losses. Roy Hill needs to lift output, but even at its capacity of 55 million tonnes, it will not get the same scale advantages as Rio Tinto, BHP and Fortescue.  

Moreover, those mines are investing in incredible automation to lift productivity, which will further reduce their operating costs compared to Roy Hill. Against that, Rinehart and the Hancock people watched the mistakes that the other three majors made and learned from them. Hancock’s partnership with the Korean, Japanese and Taiwanese steelmakers means that Roy Hill won’t have trouble selling the iron ore but POSCO and the others can’t pay above the market for substantial tonnages or they will be uncompetitive.

The message from Power’s KGB interview is that iron ore will have a difficult time for an extended period because of oversupply, (Keep away from the edge as iron ore cracks, September 24) so shareholders in Roy Hill face a miserable time funding initial losses and there will be periods when some of the lenders will be jittery. But the royalties Hancock receives from Rio Tinto are substantial and underpin the value of the Hancock empire.  

The general view around the iron ore industry is that the majors will keep pushing iron ore into the market until it reaches a price that threatens to destroy the bigger and lower cost iron ore mines and then they will pull back production. The rough guess is that level is around the $US60 to $US70 a tonne mark.

At those levels, there will be a nasty pain factor for Roy Hill but the iron ore bulls believe that in time, the development projects in China and other parts of Asia will absorb the excess capacity. Roy Hill has to hang in there and Rinehart and her partners must finance its losses. No one doubts the strength of Rinehart to do that.