Being Third in Iron Ore is Enough to Make a Man Rich

[Ed note: the following is brief adaptation from the March issue of the Australian Small Cap Investigator, edited by the DR’s Dan Denning]

The path to Australia’s first big bauxite fortune will look a lot like the same path Andrew Forrest trod in iron ore. Forrest—who according to Forbes magazine is Australia’s richest man—realised he didn’t need to compete with BHP and Rio Tinto. Just becoming Australia’s third biggest producer of iron ore would be enough to make him a very rich man.

He was right. Incredibly, Forrest’s company Fortescue Metals (ASX:FMG) has yet to ship any actual ore to China. But the inherent sense of the business proposition—and rising iron ore prices—have propelled the stock to amazing heights anyway.

Incidentally, while Warren Buffett took the crown as the World’s richest man this year (net worth of US$72 billion), India had four men in the top ten. Russia had 87 billionaires on the Forbes list. Russia’s richest man, Oleg Deripaska, is the world’s ninth-richest. He made his money in Russian aluminium, not in Russian oil.

Australia’s Aluminum Chain

The advantage of looking for bauxite where it’s already been found is that you know it’s already there. According to the Australian Aluminium Council:

Australia is the world's largest producer of bauxite, producing 64 million tonnes (mt) (36%) of world bauxite production in 2006.
Australia is the largest producer and exporter of alumina, producing 18.4 mt (28%) of world alumina production in 2006.
Australia is the fifth largest aluminium producer, with 1.93 mt (5.8%) of world aluminium production in 2006.
In 2006, the bauxite/alumina/aluminium operations employed over 13,500 direct employees and around 5,000 contractors (including 1,500 construction workers).

The heart of Australia’s aluminium business is in the Darling Ranges. In fact, they produce 17% of world’s alumina. Alcoa’s Huntley mine is the world’s largest. The other four bauxite mines are the Boddington in Western Australia, the Gove in the Northern Territory, the Willowdale in Western Australia, and the Weipa in Queensland.

Once the bauxite is refined, it usually ends up going to one of Australia’s seven alumina refineries. Those are:

• Alcan Gove (Northern Territory)
• Comalco Alumina Refinery (CAR) (Queensland)
• Kwinana (Western Australia)
• Pinjarra (Western Australia)
• Queensland Alumina Ltd (QAL) (Queensland)
• Wagerup (Western Australia)
• Worsley (Western Australia)

Alumina can then be sent off via direct shipping to a smelter in another country (where energy is cheaper, say the Middle East), or it can be turned into aluminium right here in Australia. Most alumina (85%) is smelted into aluminium, although some is used as an industrial abrasive agent.

There are five aluminum smelters in Australia. As we said earlier, it’s an incredible energy-intensive business. In the past, aluminium smelters alone have account for as much as 12% of Australia’s entire demand for electricity. This is why aluminium is the one metal often referred to as “solid electricity”.

Australia’s “Solid Electricity” (Aluminium) Smelters

• Bell Bay (Tasmania)
• Boyne Island (Queensland)
• Kurri Kurri (NSW)
• Point Henry (Victoria)
• Portland (Victoria)
• Tomago (NSW)

As it is energy intensive, the smelting business in Australia probably won’t see much expansion. Australia has plenty of potential energy (coal, uranium, natural gas). But none of it is clean, green, or cheap. And because of the high energy cost, the profit margins in smelting are smaller than the margins in alumina refining.

The Gindalbie Model and Chinese Demand

The fact that China is running into rising energy costs means it will have to curtail aluminium production. But that will not curtail its demand for aluminium. Indeed, that is the main argument for rising aluminium prices this year; that production growth will slow while demand does not.

Rising aluminium prices should be good for Aussie bauxite producers, especially those who follow the same business plan of Gindalbie Metals (ASX:GBG). Gindalbie’s plan was simple: buy up a bunch of old tenements on which everyone knew there was a resource, then go shop them around to clients in Asia.

This same strategy applied to bauxite doesn’t compete with BHP or Rio. But that is the beauty of what economists call economies of scale. A firm need not compete with Rio to become successful. It simply has to prove up its resource base to reserves and then find foreign customers eager to take that alumina from the convenient ports nearby.

The nearness of Darling Range bauxite tenements to port facilities in Rockhingham, Freemantle, and Bunbury is a big plus. Prospective bauxite firms, like the iron ore juniors, plan to negotiate off-take agreements directly with customers in Asia. The bauxite is mined in Australia and shipped as ore to Asia.

Judging by joint infrastructure products between Aussie-based Murchison and Japanese-based Mitsubishi in the iron ore business, and investment agreements between Yilgarn Infrastructure and five Chinese partners (approved in January by the Foreign Investment Review Board), neither the Western Australian or Federal government’s have trouble with Aussie firms having foreign partners.

In fact, without the joint venture partners, it’s not likely these bauxite and iron ore tenements (which are not large enough for the big boys to produce) will ever be produced at all. But such is the marginal demand for commodities coming from China today (and for the next 10 years we reckon) these smaller companies stand a real chance to take a resource everyone knows is there and turn it into a profit-making venture for shareholders.

Regards,

Dan Denning
for The Daily Reckoning

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