Bloomberg.com: Rio seeking Chinese partner for West African ore mine, Financial Times says
Dear China,
You do a lot of business in Africa. We have a great project, but it is a bit risky–do you want to put some capital into it? We only want $4 billion or so, and we will give you a 30% stake, and by the way, we want to keep marketing rights.
With love,
Rio Tinto
By 2012 the Canadian government does not want any new coal-fired power plants. Strong words; for some they would be fighting words. I can understand the rationale. I can even understand the political necessity. My question is what do you replace it with?
People talk about renewable energy, and I am a firm believer in it, as long as, if it is hydro, it is run-of-river and does no harm. I love wind, but that will never be more then 20% of a grid. I think solar is great if we can get the capital required down. In theory we should be able to reduce our use of coal completely in the coming years, but the question just comes down to cost.
While we’re trying to reduce our use of coal, we are simultaneously wildly expanding oil sands projects. For these, we burn lots of natural gas to bake the oil out from the sands. To put that in perspective, we are burning one carbon fuel to release another one, so we can then burn the second carbon fuel in a car, because natural gas does not go into a car’s gas tank.
But do not worry, we have a solution to burning all these fossil fuels. We are going to plug in our cars and use even more power off our grid. We are going to get off that Saudi oil that is so expensive and replace it with domestic electricity.
The question just is where are we going to get the volts. Are we going to have acres of wind farms, or millions of acres of corn, are we going to be doing biomass plants where we burn slash from wood cuttings, or are we going to have other solutions?
If we want plug in green cars and get even more power off the grid, and at the same time we want to ban coal, the net result will drive the price of electricity to at least double the rate today.
Bloomberg.com: Australia coal-mine floods raise costs of cars, planes, washers
Many people have this supply and demand curve that keeps on moving: They believe that while pricing of resources is being driven up by China’s purchases, at some point supply is going to exceed demand and we are going to have a price decrease. This flood in Australia shows the problem with that curve. Historically a flooded coal mine would not matter. Production would shift and there would be enough excess capacity in the production of coal that prices would not more than double. But with China buying so many resources today, that’s all changed.
The end result is neat: one mine goes down, profits double. What is going to stop the big three iron ore producers or coal producers from just cutting production 20% to keep prices high? Volume is not the business here. No one has huge leverage. Everyone has nice margins. When the next slowdown occurs, a simple dam failure would cause prices to stay high. Just a few mine closures for a few years for refurbishment would have the same effect.
Oligopoly theory throws classic supply and demand economics out the window. People forget to write in the classic floor that price setters can set. This flood shows that floor very nicely.
Reuters: Three Chinese groups eye Fortescue iron ore stake
Congrats to Andrew Forrest, Australia’s richest man, on shipping the first ore, and to Harbinger Capital Partners on their possible sale of 16% of Fortescue to the Chinese. The fact is this was a brilliant investment in its timing all the way around, and a real home run. One of the things that it has proven to me is how powerful a charismatic CEO can be; Forrest pushed this through when everyone, including me, doubted. At this point he has some real value: a port, a rail line, and some ore bodies. He now gets the issues of growing the project to justify the market cap, but he could go off into the sunset with a sale of his stake on top of Harbinger’s stake and declare it a win. It sure would be interesting to see Fortescue 49% owned by the Chinese, and it would really mess with the oligopoly.
Suppliers have lots of power in most industries, and the mineral industry is no exception. To make a mine work, you need a few key resources beyond an ore body, and to get these you will need to work with suppliers. You need the logistical ability to get the ore to market, the power/energy to process the ore from its in situ state to a marketable state, the equipment to do the mining and the processing, the human capital, and the governmentally supplied right to operate.
Logistics, as everyone knows, can make or break any project. There is a point where the cost of the rail line or the slurry line outweighs the value of the product. For example, the cost of trucking from a gravel operation rapidly makes gravel only make sense as a local product. It used to be that more than 60 miles from the quarry to the customer for most markets was not economical for the product. Iron ore bodies require rail lines, and at times the suppliers of those lines—like in India and South Africa—have significant pricing power over the mining companies. Expansions and/or operating costs can and have been dictated by rail lines not owned by the mining companies. This is one of the reasons why iron ore companies so fiercely defend their own rail lines and the right to operate without interruption.
Energy is now a big issue, but what is interesting is that it is a cyclical issue. In Africa power is a big deal for mining companies (see my post from a couple weeks ago). The ability to get energy or electricity can significantly impact the value of a mine. The ideal state for mining companies is having long-term fixed price contracts for electricity or fuel, but that rarely happens unless you are in a downstream marketing situation like processing direct-reduced iron, aluminum, or alumina from bauxite.
Equipment is a cyclical issue that can represent a barrier to entry in the short term, but I have never seen a long-term economical project killed for lack of a tire or a truck. It is not like Komatsu or Caterpillar has the key truck for moving tonnes of iron ore and you can only use that one brand. Most mining equipment has low long-term switching costs. That is not to say that there are not large short-term market issues with equipment, but in the long term this is not a force that really scares me.
Human capital is hard to understand the value of. When you are undermanned and prices are high, that last guy is worth a lot of money. When prices are low and you are overstaffed, that last guy is hard to get rid of. I guess labor relations always matter in this business, and if you cannot get a guy to do work that needs to be done, it shuts you down. Again, though, this can be a long-term legacy issue if you are dealing with old line union operations, or a short-term boom-bust market issue. It, however, is not a barrier to entry, and the human capital really only has room to negotiate for higher prices when the market prices for the commodity goes up.
The government supplies the right to operate, and if you do not comply with the government of an area, they will shut you down. This supplier matters less if you are making sports shoes and you can set up shop one country over three weeks later. But ore bodies do not move, and so the government has lots of power as a supplier of permits and core laws. The counter issue, of course, is that governments want the tax revenues from businesses.
On the whole, the real structural barriers to entry are transportation and energy supply. These are the relatively fixed barriers and the suppliers of these things have the most long-term power. All the other supplier issues for this business can and will be solved as there are more suppliers in the long run than customers, and the cost to switch mining trucks or truck drivers is much lower than the cost of a bad contract. Of course unions and non-captive infrastructure that is core both will impact and the long-term profitability and success of any mine.
