Friday, May 27, 2005

WSJ : China's Demand For Steel Products

Entrepreneur Mines China's Demand For Steel Products
Mr. Forrest's Vast Ore Claims, Deep in Australian Desert,
Draw Money and Questions

Buyers Said to Be 'Desperate'

By PATRICK BARTA Staff Reporter of THE WALL STREET JOURNALMay 27, 2005; Page A1

NEWMAN, Australia -- Andrew Forrest is known for wild plans with long odds. He once imported alpacas from the Andes to sell in Australia and used Cuban technology to build a high-risk nickel plant in the middle of nowhere.

Now, Mr. Forrest is onto an even more ambitious project that has the world's mining giants taking notice. He is planning to develop, in an unlikely alliance with China, what may be one of the planet's largest untapped mother lodes of iron ore.

It isn't clear that this mammoth venture will actually materialize: Doubts remain about the quality and accessibility of Mr. Forrest's ore, and his prospective Chinese partners have yet to fully agree to the deal. But the fact that the maverick entrepreneur is finding himself under a global spotlight showcases just how desperate manufacturing nations like China have become to ensure supplies as prices for raw materials soar.

China is the world's biggest maker of steel. It has been especially hurt as suppliers this year pushed through a global 72% price increase for iron ore, a key steel-making ingredient. Liu Yongshun, president of mineral resources for Baosteel International, a subsidiary of Baoshan Iron & Steel Co., China's largest steel company, has warned that the country's entire $140 billion steel industry could become unprofitable -- perhaps as early as this year -- if alternative sources of ore don't open up. "The whole Chinese steel industry would like to see more suppliers," he says.

That is where Mr. Forrest comes in. A 43-year-old who goes by the nickname Twiggy and often flies coach, Mr. Forrest has amassed rights to vast ore resources deep in the deserts of northwestern Australia.

Extracting and transporting that ore will require massive investment. Chinese officials informally agreed in a meeting late last year that it was "in line with China's natural-resource strategy" to develop Mr. Forrest's assets despite the risk, according to the Web site of one corporate participant in the meeting, China Metallurgical Construction Group Corp. Meanwhile, China Metallurgical and two other state-run companies reached a separate agreement with Mr. Forrest to front as much as $1.4 billion for the plan, though the Chinese maintain that further negotiations -- and more proof of Mr. Forrest's ore -- are necessary before final terms are settled.

Such upfront investments to secure raw materials aren't uncommon for China, which seeks to protect its burgeoning manufacturing sector as global mining giants show wariness of expanding too quickly. "They're desperate -- that's the bottom line," says Len Dean, managing director of Sesa Goa Ltd., an iron-ore mining company in India.

"We plan to be the next major iron-ore power in the world," Mr. Forrest says. "With the resources we have, it would be irresponsible to shareholders to plan to be anything else."

In an indication of investors' eagerness to cash in on new mining ventures, shares of Mr. Forrest's company, Fortescue Metals Group, soared nearly 11-fold on the Australian Stock Exchange between October 2004 and March 2005, as positive word of mouth about the project spread. Since March, the shares have fallen more than 50%. Despite the recent decline, the company has a market capitalization of about $430 million. Mr. Forrest, who says he was already financially secure from his past ventures, now holds about 100 million shares valued at around $190 million.

The rights that his company holds are in a desolate stretch of the Australian Outback known as the Pilbara, one of the world's richest known iron-ore deposits. Anglo-Australian concerns BHP Billiton PLC and Rio Tinto PLC, which along with Brazil's Companhia Vale do Rio Doce SA control three-quarters of the world's seaborne iron-ore trade, have long operated in the area.
They own the only two railroads there as well as some port facilities. Until recently, most other investors weren't interested in the Pilbara because iron-ore demand wasn't growing rapidly, and the cost of building their own ports and railroads was deemed prohibitive.

Mr. Forrest thought otherwise. Gambling that demand would rebound in a big way, in early 2003 he began assembling mineral rights, including large sections that previously were controlled by BHP Billiton and Rio Tinto, and that were generally considered too remote and containing ore of excessively low quality to be of much value. He says he has spent more than $6 million of his own money to launch the company, which now has more than 80 employees.

To date, Mr. Forrest has identified two billion metric tons of iron ore, according to an independent consultant he had hired. By Mr. Forrest's estimates, those holdings could produce as much as 45 million metric tons a year, enough to make Fortescue one of the world's largest suppliers.

'They're Not Laughing Anymore'

On a recent day, with the mercury topping 110 degrees, crews hired by Mr. Forrest drilled holes up and down the Pilbara. Their equipment, similar to oil rigs, extracted dirt samples that geologists use to gauge where more minerals might be found. Some of the samples were light brown -- not a hopeful sign. Others were a deep red or rust color -- a possible indication of iron-ore deposits.

"A year ago, all this was a bit of a giggle" to the Australian mining community, which assumed the area couldn't be profitably mined, says Fortescue's senior geologist, Doug Kepert, who left a job at BHP Billiton to join the team. As more iron ore is discovered, he says, "they're not laughing anymore."

The project may still never amount to much. Rival mining executives and some analysts contend that Mr. Forrest is simply trying to take the Chinese for a ride, cashing in on their desperation for raw materials with a substandard mineral.
"He's glossing over technical issues that are significant to the viability of the operation," says Peter Hickson, a basic-materials analyst for UBS in London.

The Australian Stock Exchange has issued several demands for more information, including details about the potential for cost overruns. Fortescue responded with a letter indicating that costs could indeed rise beyond initial estimates due to higher labor, fuel and other costs.

A descendant of a famous Australian Outback explorer, Mr. Forrest says he came to love big mining projects as a young man, after visiting a Pilbara mining operation whose size and complexity dazzled him. Later, in the 1980s, he moved to Sydney, where he became an investment banker.

A few years later, he hatched a plan to import alpacas, the furry South American animals whose wool is used to make sweaters. Mr. Forrest raised $2.3 million to bring them in from Chile and Peru. The project ran into trouble after a legal dispute over the animals' ownership. Mr. Forrest concedes there was a dispute, but says his alpacas ultimately formed the foundation of a thriving industry in Australia. His mother still owns some.

By the mid-1990s, Mr. Forrest was ready for far bigger game: a complex mining project in Western Australia called Anaconda. Although he lacked any meaningful experience running a mine, Mr. Forrest thought his contacts in the investment community would enable him to pull off the plan. He left the execution to experts.

Geologists agreed the area he had in mind contained large deposits of nickel, a metal that is used in everything from jet engines to kitchen utensils. But they figured it wasn't commercially viable, partly because of its low quality -- the same kind of concerns heard about Mr. Forrest's current iron-ore plan.

Mr. Forrest sought to solve the mine's challenges through technology used in Cuba that involved building a massive facility in the middle of the desert to process the mineral. Although many mining experts said the project would never work, he managed to raise more than $1 billion, including $420 million in junk bonds in the U.S. Major investors included Glencore International, the Swiss trading company founded by former U.S. fugitive financier Marc Rich.

The project soon ran aground amid huge technical problems and ballooning costs. After bitter infighting, large shareholders forced Mr. Forrest out and persuaded bondholders to sell their stakes at a loss. Lawsuits emerged. In one case, two bankers claimed Mr. Forrest and others failed to meet an obligation to pay more than $1 million in fees for their work. In its ruling in favor of the bankers, the Supreme Court of New South Wales determined "it would be unsafe to rely on any account" given by Mr. Forrest, calling him "quite untruthful." Mr. Forrest disputes the judge's characterization.

Last year, Fluor Corp., a U.S. engineering firm involved in the project, agreed to pay more than $100 million to the mine's current owners, settling claims that it had been responsible for many of the project's flaws. A Fluor spokesman declined to comment beyond previous news releases.

Mr. Forrest says the project was ultimately a success: Today, with nickel prices high, Anaconda -- now known as Minara Resources -- is a profitable operation for its remaining shareholders, which include Glencore.

It wasn't long before Mr. Forrest was hungry for another megadeal. He eventually chose iron ore, in part because he knew the Pilbara well, befriending local Aborigine leaders. He doubted that BHP Billiton and Rio Tinto had depleted the area's resources.

BHP Billiton and Rio Tinto executives responded by warning investors and iron-ore buyers that it wasn't wise to trust untested players, especially in times of tight supply. "When you are operating a very large steelmaking facility, you want absolute surety of supply -- not only in terms of volume, but in terms of quality," cautioned Sam Walsh, CEO of Rio Tinto's iron-ore business. The two giants announced their own Pilbara expansion plans. They also refused to grant Mr. Forrest access to their rail lines and questioned the quality of his minerals.
Industry analysts say the ore mined by BHP Billiton and Rio Tinto is often as much as 64% iron. Mr. Forrest says the iron ore at his main deposit is on average between 58% and 60% iron. This isn't necessarily a problem, since widely accepted technologies exist to upgrade the ore. But doing so will add costs that could make it harder to make a profit on the finished product, especially if iron-ore prices come back down. Although many commodity prices have declined some in recent months, iron-ore prices are typically set according to annual contracts that won't be renegotiated until later this year at the earliest.

Tensions mounted. Last year, Mr. Forrest was quoted in the Australian press calling the other companies "un-Australian" and a "duopoly." In a speech last September, Rio Tinto's chief executive, Leigh Clifford, shot back, responding that the "glib" use of such terms wasn't helpful to the industry.

Cultivating an Alliance

Through all this, Mr. Forrest was cultivating his crucial alliance with China. This included a late-2003 trip to the city of Ma'anshan to pitch his project to steel makers that grew increasingly nervous about the dominance of global mining giants.

By November of last year, Mr. Forrest announced a series of contracts with Chinese companies to buy his product. More importantly, he enticed three state-owned companies -- China Metallurgical, China Railway Engineering Corp. and China Harbour Engineering Co. -- to reach an agreement announced before a room of Beijing reporters to finance a rail line, port and other infrastructure.

Some of the Chinese partners were later annoyed that Mr. Forrest boasted about the infrastructure-financing agreement and treated it as if it were final. The Chinese believed the agreement was subject to additional negotiation, according to a person familiar with the matter. Mr. Forrest has maintained that the companies are bound by the deal.

More recently, the relationship has gotten rockier. In March, the president of China Metallurgical was quoted in an Australian newspaper saying China wasn't yet fully committed to the project and wanted more assurances about the size and quality of the ore. Shares of Fortescue Metals tumbled on the news.
Mr. Forrest responded by accusing the company of trying to bully him into giving up a bigger stake in the project. He released copies of the companies' past agreements and announced he was in talks with other parties to build the necessary infrastructure if China wasn't interested.

He has also retained outside consultants to help promote the project, including a U.S. steel-market analyst named Peter Marcus whose firm, World Steel Dynamics, produces market-forecast reports that are widely read in the industry. Although Mr. Marcus says he hasn't done his own due diligence on the ore, he is willing to put his reputation on the line in part because he trusts Mr. Forrest.

"I have not detected a man who lacks integrity," he says. He says "at least three" undisclosed international steel companies are now interested in investing.
An official at one of the three Chinese companies says the Chinese still want to develop Mr. Forrest's ore and are hoping to gain more control over the project. "Only a controlling stake could cover the business risks we are taking," this official says. Even so, "we have no intention to withdraw."

Bankers who are involved in the project, meanwhile, say they believe China simply wants to send a signal that it isn't gullible, and will play hardball to make sure it maintains maximum control over the ore.

In the meantime, Mr. Forrest is plowing ahead. One recent day in the Pilbara, he bounced around from meeting to meeting in the vicinity of the mining town of Newman. The walls of his local headquarters, a ranch house, were covered with maps of ore deposits. Next to them hung a poster of Latin American revolutionary Ernesto "Che" Guevara, emblazoned with the words "Hasta la victoria sempre" -- "Onward to victory, always."


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