Chinalco shells out $1.35 billion to get a slice of Rio Tinto’s Simandou Iron Ore Project

Relations between Australia and China appear to be thawing quickly, just as Rio Tinto (LSE, ASX:RIO) and Chinalco, China's largest aluminium producer, start to look at ways to co-operate again on large undeveloped projects.  

For those of us with foggy memories of anything further out than 12 months, Chinalco and Rio Tinto have courted each other before. Back in 2008, Chinalco came close to taking a significant stake in several projects operated by the Australian mining giant in a US$19.5 billion deal. The proposed deal received a frosty reception from both Rio Tinto’s shareholder base and the Australian Government, and in the end, was scuppered after commodity markets recovered just enough to allow Rio Tinto to tap the markets for cash and embark on a round of asset disposals to shore up its balance sheet.

This all seems like ancient history now, with iron ore, copper and many other commodities recovering strongly, and with it, the market valuation of the world’s mining heavyweights, but the memories of the failed deal are being stoked up again as four Rio Tinto employees who were arrested in August 2009 are set to go on trial in China charged with commercial spying.

China is Australia’s largest trade partner, and in many ways both countries are reliant on the other. Australia’s export led economy has boomed in recent years, thanks to China’s insatiable appetite for natural resources, especially coal and iron ore – which Australia has mountains of. 

On the flip side, China’s strong growth is highly dependent on securing supply of key resources required to fuel the development of its economy.  This has been the key to tensions between the two. Indeed, the first quarter of each New Year brings the same debate: iron ore contract prices. 

China is the largest producer of steel, and at the moment, just three companies control the seaborne iron ore market – Rio Tinto, BHP Billiton (ASX:BHP, LSE:BLT) and Vale (NYSE:VALE).  With that kind of control, it doesn’t come as much of a surprise that the ‘big three’ try to push through price increases every year, and equally unsurprising, steel manufacturers do their best to avoid any increase! 

One way round this conundrum for steelmakers in China is to try and source other supplies. As many large industrial groups in China are still state backed organisations, there has been a concerted effort and a lot of cash directed at snapping up iron ore assets across the globe that the Chinese can export home. 

So while Rio Tinto, BHP Billiton and Vale are keen to keep control of iron ore markets, in many cases, due to capital costs, or political risk, they require a partner to develop certain projects. This appears to be the logic with the Memorandum of Understanding (MOU) announced this morning that essentially will see Chinalco invest US$1.35 billion for a 44.65% stake in the Simandou Project in Guinea.  

Press speculation in recent weeks has been rife with rumours that Rio Tinto and Chinalco were back at the table again looking at deals. Initially speculation focused on the world class Oyu Tolgoi Gold-Copper project in Mongolia, which is situated close to China’s border, and requires a huge dose of capital to be developed, but perhaps more logically, the two companies plucked for an iron ore asset in West Africa, often tricky region politically but an area that China has been more than willing to pour money into.

Rio Tinto currently owns 95% of Simandou, with the remaining minority stake held by the International Finance Corporation (IFC), an arm of the World Bank. 

Under the terms of the MOU, the project will be vended into a new joint venture, in which Chinalco will acquire a 47% interest by providing US$1.35 billion that will be used to sole fund development of the project over the next two to three years. Once the full sum is invested, Chinalco’s interest will fall to 44.65% with Rio Tinto retaining 50.35% and the IFC 5%. All three parties could also be diluted by Guinean Government who holds an option to buy up to 20% of the project.

Once fully operational, the mine is expected to produce over 70 million tonnes of iron ore per annum.

"We have long believed that Rio Tinto and Chinalco could work together on major projects for mutual benefit. Chinalco is an excellent partner for us in Simandou. Chinalco brings its own skills and capabilities in major projects and access to the infrastructure expertise of other Chinese organisations,” Tom Albanese, chief executive, Rio Tinto said. “We believe the Simandou project is a large scale, long life asset and is the single best undeveloped source of high grade iron ore. By working with Chinalco and the IFC we expect to realise great economic and social benefits for Guinea, and great value for our shareholders."

Investor’s will no doubt be speculating on the significance of this morning’s deal. Could it influence the criminal trial in China? Will there be more deals announced between Rio Tinto and Chinalco? Only time will tell.