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Rio Tinto’s iron ore expansion dilemma

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    Rio Tinto’s iron ore expansion dilemma

    PUBLISHED: 4 hours 13 MINUTES AGO | UPDATE: 3 hours 24 MINUTES AGO

    Matthew Stevens

    Rio Tinto finds itself on the horns of an impressive herd of dilemmas and not all of them are sired by Glencore's Ivan Glasenberg and his appetite for a second run at merger with the Anglo-Australian miner.

    At some point later this year Rio's investment committee will sit down to make a firm decision on whether or not to start filling the final 10 per cent or so of the 360 million tonnes of iron ore infrastructure capacity that is currently in the final stages of completion.

    As things stand, Rio has plans to squeeze its existing 15-mine fleet to make the output step-change needed to be running the new system at a 350mtpa run-rate by 2017.

    But, according to the revised expansion plan drawn-up by iron ore boss Andrew Harding back in 2013, fully filling and then sustaining Rio's new export footprint over the longer haul is going to require investment in two new mines, first Silvergrass and then Koodaideri.

    Harding's spectacular redesign of Rio's Pilbara growth story added 10 million tons to Rio's Pilbara export target while cutting $US3 billion ($3.8 billion) from the capital cost. A key plank in the changed capital platform was that a decision on Silvergrass was pushed back nearly two years until the third quarter of this calendar year with D-day for Koodaideri pushed to 2016 at the earliest.

    That Silvergrass will get the nod sometime around September is pretty much accepted wisdom in the market. It will cost all of $US1 billion. Koodaideri, which is planned to be substantially bigger, will cost considerably more. But we are hearing the investment decision might be a closer run debate than is being anticipated for a collection of intersecting reasons.

    First, there is the question about allocating scarce capital to new iron ore anywhere. Then there is the question about whether Rio's longer term ambitions in iron ore would be rather better served by using that capital elsewhere in the miner's iron ore world. Then, even if the Pilbara pass both those tests, there is the question about whether Harding and his people can perform another miracle by working out a way to sustain 360mtpa, without Silvergrass.

    Rio will spend about $8 billion on sustaining and growing its business over the coming financial year and the current plan is that this will be the annual capital investment ceiling for the foreseeable future.

    Projects routinely slated for approval over the coming 18 months include the Pilbara 360, the $US1 billion South of Embley bauxite mine near Weipa, the $US6 billion Oyu Tolgoi underground, and some rather less expensive Hunter Valley expansions.

    Missing from that list though is the wildcard in the Rio iron ore pack: the troubled, controversial, complicated but nonetheless fabulous Simandou project in Guinea. Rio insists that Silvergrass and Simandou are not either/or propositions. But ticking off on both in the foreseeable future would seem a tough narrative to sell to a dividend hungry investment market.

    Simandou has been a jewel on Rio's horizon for two generations of management. It would be a monstrously hard and expensive project. Its over-ridding attractions are its size and quality. It hosts enough, 65 per cent iron ore to sustain a 100mtpa mine for 30 years and more. But just the mine could cost $US6 billion with Rio's share of that about $US2.4 billion. Then building the 650 kilometre of new railway and new deep water port needed to support that mine could cost another $US14 billion.

    That, obviously, is an awful lot to spend in a frontier destination like Guinea, which endures from politics occasionally even more immature than Australia. As a result, understandably, there is a consensus that leaves Simandou off Rio's list of most likely investments.

    But Rio has achieved much over recent times in de-risking Simandou with its continuing financial exposure now limited pretty much exclusively to funding its 46.5 per cent of the mine. The proposition afoot is that the infrastructure would be funded and operated by a special purpose vehicle supported by "world class international investors". Over the past month or so Rio's Simandou team have been touring capital markets in Europe, the US and the Middle East in search of those world class investors. Some quiet optimism has been generated by their progress.

    Whether it is realistic or not, Rio is now under some considerable pressure from its hosts and partners in Simandou to get a wiggle on towards an investment decision. Having signed an investment framework last May, the Guinean government is as impatient for progress as Chinalco, which paid $US1.7 billion for a 47 per cent share in the project back in June 2010.

    The balancing act for Rio is that it really wants to keep its feet firmly on what is a once-in-a-generation mineral deposit, while also living within the constraints of its capital ceiling and value-focused investment philosophy.
    Coincidentally enough, the chairman of the Simandou joint venture, Rio's diamonds and industrial minerals boss Alan Davies, offered a subtle whack at two of the miner's biggest competitors on Thursday.

    Speaking to the Melbourne Mining Club, Davies offered the view that exploration was a critical part of mining's value chain. This, of course, is a view openly rejected by Rio's erstwhile and possibly future suitor, Glencore, and increasingly questioned by fellow Anglo-Australian, BHP Billiton.

    Davies went on to suggest that emerging exploration technologies have the potential to revolutionise the search for minerals in the same way that horizontal drilling techniques have transformed the onshore oil industry.
    Over to you Ivan.
 
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