The Chinese Dream of Simandou

In today's Finshots, we talk about the Simandou saga or as The Economist called it - a titanic battle between the giants of iron-ore mining for control of the world’s richest deposits.

This one is a must read!!

The Story

Let’s start with the principal actor — Rio Tinto. Rio Tinto is an Anglo-Australian company that is primarily focused on the extraction of minerals. But their key focus — Well, that’s always been iron ore. So when the company acquired the exploration rights at Simandou back in 1997, many people thought it would change the company’s fortunes forever.

Because Simandou was unlike anything anybody had ever seen. Tucked away in the remote mountains of southeastern Guinea, Simandou hosts the world’s largest known untapped deposit of iron ore — with enough ore to sustain roughly 7% of the global iron-ore output, annually. And better yet, the iron ore found in the mines held unusually high iron content, prompting some people to hail Simandou as the “El Dorado” of iron ore.

But nearly a decade after initially acquiring the rights to mine Simandou, Rio Tinto hadn't actually mined anything. Why you ask?

Well, the problem wasn’t with the mining per se. But the prohibitive cost of transporting the iron ore from Simandou to the ports. See, if you can’t get the iron ore on ships and transport it to other parts of the world, there’s no point in mining the ore. According to some estimates, the potential cost of building the infrastructure — including railway lines and ports tallied up to $20 billion — a gargantuan sum, even for the mighty Rio Tinto. So they kept dragging their feet until one day in 2008, the then president of Guinea, stripped Rio Tinto of half its rights. Simandou was divided into two blocs and while the rights to the southern bloc remained with Rio Tinto, the northern blocs were put up for sale.

And you could see why the president resorted to such a move. If Rio Tinto had actually developed the mines, it would have been Africa’s largest infrastructure project ever. It would have lifted Guinea out of poverty and obscurity. But since Simandou remained undeveloped, Guinea’s patience finally wore off, and soon, the rights to mine the mountains were awarded to another company — B.S.G.R. or the Beny Steinmetz Group Resources, run by the diamantaire, Beny Steinmetz, the richest man in Israel.

However, the award was dogged with controversy since BSGR had no experience developing iron ore mines. Even worse, they had paid no money upfront, as is customary with such licenses. And by investing a mere $160 million, the company managed to transform its investment without actually doing much. But then things took another interesting turn. In 2014, the Guinean government stripped BSGR of its rights to mine Simandou after finding that the company had bribed government officials to win the contract. BSGR refuted these allegations and sued the government. Eventually, however, BSGR had to forfeit its rights to mine the northern blocs in Simandou.

Ouch!!!

Oh, in the meantime BSGR had sold 51% of their interest (in Simandou) to the Brazilian mining giant, Vale for $2.5 billion. And they pocketed a cool $500 million in the process. So once they lost the mining rights, Vale was visibly upset.*

So perhaps now is a good time to introduce Vale and discuss a little about the iron-ore cartel. Over the last six decades, three mining companies — Rio Tinto, Vale and BHP have come to consolidate and corner nearly 70% of the global seaborne iron ore trade. Possibly, even more, considering this number is slightly dated. And the triumvirate has largely been responsible for moderating supply and keeping prices in check.

But not everybody wants to play along. Especially, the Chinese.

See, China is the world’s largest steelmaker. Yet, it imports close to 70% of the world’s iron ore — the key raw material needed to manufacture steel. As one article in the Economist notes —

It is in the odd position of having world-leading technology companies but barely a toehold in one of the most basic industries of all, iron-mining, at a time when prices above $100 a tonne are throttling its steel mills.

So the Red Dragon has been plotting away trying to control supply and source iron ore at competitive prices for a while now. And in a bid to achieve this objective, the Aluminium Corporation of China Limited or more popularly referred to as Chinalco entered into an agreement with Rio Tinto to develop the southern bloc in 2010.

In fact, at one point it seemed as if Chinalco was going to buy out Rio Tinto' stake in the join venture and control the entire southern block at Simandou. This was at a time when iron ore prices had dipped from the highs of $187/ton (in 2011) to $41/ton (in 2015). And while the deal eventually collapsed in 2018, China hasn’t curtailed its ambitions. In 2019,  a Chinese-backed consortium secured rights to the northern blocs at Simandou as well. And recently, they announced their plans to invest $14 billion in a bid to develop Simandou’s northern mines. This involves building the transport infrastructure, including the ports. And while this might seem like a positive development, it leaves Rio Tinto isolated.

On the one hand, if the Chinese consortium builds out the infrastructure for the northern bloc, Rio Tinto could use their ports to ship iron ore across the world. Granted, they might have to pay a premium, to use these facilities, but they won’t have to worry about the upfront investment.

On the flip side, if Rio joins in on the act and starts mining the southern blocs it could create a glut in supply, pushing prices even lower. And for a company whose fortune rests on price inflation, that might not be a very enticing proposition. So will they forge ahead and commit to developing the mines. Or will they keep dragging their feet?

The answer to this question might finally determine Simandou’s fate.

Until then…

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*Also Vale is currently suing BSGR, the diamond company for roughly $2 billion after accusing them of fraudulently inducing them to buy a 51% stake in the Simandou mines (northern bloc). Considering, you know, they obtained these rights through corruption?