Has Rio Tinto Halted The Simandou Project Over Financing Issues?

Rio Tinto (NYSE:RIO) has effectively halted further progress at its Simandou iron ore mining concession, according to unnamed sources in the Guinean government. The company merely responded by saying that it has not frozen the project and is committed to its development. ^[1]

The Simandou iron ore deposit is one of the world’s richest and Rio Tinto, along with Chalco, owns the right to half of the deposits. The other half is owned jointly by Vale and Beny Steinmetz Group Resources. Even Vale, which holds a 51% stake in the joint venture, has put the project on hold due to financing issues.

Rio’s new problems at Simandou are due to the reluctance of the Guinean government to exercise its option of taking a 51% stake in the venture to develop railway infrastructure for the mine. The construction of the 670 km line is expected to cost $10 billion and the country is reportedly not keen to take on an obligation of $5 billion when it recently received debt relief. ^[2]

The latest twist in the long running Simandou saga may result in Rio’s concession being cancelled by the government if the company misses its 2015 deadline to start shipping ore.

See Full Analysis for Rio Tinto Here

A Primer On The Simandou Project

Rio Tinto was granted rights to mine Simandou in the 1990s by the then dictatorial regime. In 2008, the regime of the day stripped Rio of rights to half the concession saying that it had missed deadlines to start mining. The half taken away was given to Beny Steinmetz Group Resources, which in turn sold a 51% stake to Vale in 2010 for $2.5 billion. ^[3]

In 2011, Rio reached a deal with the Guinean government to pay $700 million as a one-time cash payment to take care of all the complex issues and objections raised by the government. The company also agreed to grant the Guinean government a 35% ownership of the mine over a 20-year period, some of it for free. The same agreement also gave the government the option to acquire a 51% stake in the company created for the purpose of setting up railway and port infrastructure. ^[4]

In 2012, Rio entered into a joint venture with Chalco, a subsidiary of the Chinese company Chinalco. Rio Tinto and Chalco now hold 53% and 47% respectively in Simfer Jersey Limited, a Rio Tinto subsidiary. Simfer Jersey in turn owns a 95% stake in Simandou. Thus, Rio Tinto and Chalco own a 50.35% and 44.65% stake respectively in Simandou. The remaining 5% is owned by the International Finance Corporation, which is part of the World Bank. Over the next 20 years, the Guinean government has the option of taking a 35% stake in Simfer Jersey. ^[5]

Why Rio Might Be Slowing Down Progress

Rio Tinto officials have told the Guinean government that work at the mine would grind to a halt if an investment agreement and infrastructure financing was not put in place quickly. Guinean officials say that they have not taken a final decision on the state’s role in the infrastructure venture. The reluctance is understandable given that it is not easy to commit funds to the tune of $5 billion when the country is receiving debt relief from outside. The amount of $5 billion is equivalent to Guinea’s entire Gross Domestic Product (GDP).

It is difficult for Rio to go ahead on its own because it is under pressure from investors after a disastrous performance last year and uncertain future commodity prices. The company reported a net loss of $3 billion for 2012, down from a profit of $5.8 billion in 2011. This was largely due to hefty impairments worth $14 billion on account of writedowns in the aluminum and Mozambican coal businesses.

Like many of its peers, Rio is looking to cut costs because of pressure from investors and an uncertain outlook for commodity prices. It has committed itself to cost savings worth $5 billion over the next two years.

Likely Consequence Of Halting Work

Rio’s Simandou contract states that if it misses the 2015 deadline for first commercial production, the government has the right to initiate proceedings to terminate the concession. As mentioned above, the company has already suffered that once back in 2008, so the possibility cannot be ruled out. There are many other mining players waiting in the wings to lay their hands on the Simandou deposit, which strengthens the government’s hand.

Since Rio has denied freezing the Simandou project, we will have to wait and keep an eye on further developments before being certain of a final outcome.

We have a Trefis price estimate for Rio of $45 which will be revised now that the fourth quarter earnings results are out.

Understand How a Company’s Products Impact its Stock at Trefis

1. Rio Tinto slows Guinea iron ore investment, MineWeb [↩]
2. Rio’s hold on Guinea venture in doubt, Financial Times [↩]
3. Rio strikes deal on Guinea mine, Financial Times [↩]
4. Guinea – what lies beneath, Financial Times [↩]
5. Rio Tinto Q4 2012 Results, Rio Tinto Media Release [↩]