Chinese money makes the desert bloom

Zeljko Zaic, a leathery-skinned surveyor at a Chinese-backed mining company, stands atop a sun-scorched ridge in the Australian Outback and kicks a lump of red iron ore lying on the trail.

"One day soon this will be part of someone's house in China," he says.

In only five months, this 1900sq km stretch of semidesert in the midwestern region of Western Australia has been transformed from a desolate habitat for bush flies and kangaroos into a base for the next wave of the nation's mining boom.

Below the 80m high ridge, Australia's Gindalbie Metals has joined China's Anshan Iron & Steel Group to build a A$1.8 billion ($2.3 billion) iron ore mine. The project includes a nine-storey processing plant, a township of air-conditioned homes and a pub, restaurant and cricket pitch for 1500 workers.

Fuelled by China's appetite for minerals, about 50 publicly traded mining companies, many with a market capitalisation of less than A$2 billion, are spreading out mostly in Western Australia, a region four times the size of Texas with a population of just 2.2 million. Chinese investors, mainly state-owned steelmakers, have funded at least 20 of these outfits as part of Beijing's move to reduce its dependence on Melbourne-based BHP Billiton, the world's biggest miner, and Rio Tinto Group, the No 2 iron ore exporter.

The shares of eight Chinese-backed iron ore firms leaped as much as 15-fold from 2005 to 2010, turning a handful of entrepreneurs into actual or aspiring billionaires.

"It's been life-changing for some of these people," says Tim Schroeders, who helps manage US$1 billion ($1.43 billion), including mining shares, at Pengana Capital in Melbourne. "It would have been a pipe dream 10 years ago to think you could compete with the world's biggest mining companies."

The global financial crisis put a momentary damper on the five-year Australian mining frenzy. Three months after the spot price of iron ore plunged by more than 60 per cent to US$59 a tonne in March last year, relations between Australia and China also took a nosedive. In June, London-based Rio Tinto rejected an investment from Aluminum Corp of China, known as Chinalco.

Soon after, Chinese authorities arrested and indicted four Rio Tinto executives on charges of stealing commercial secrets and bribery. At the time, Australian politicians in Canberra decried the arrests as an act of retaliation and Rio Tinto said the allegations were without foundation.

The four, including Australian citizen Stern Hu, received jail sentences ranging from seven to 14 years.

As China's economy speeds up again, spurring record iron ore imports, political tensions are fading. The government of Prime Minister Kevin Rudd, a Mandarin-speaker and former diplomat in Beijing, said in March that the arrests were separate from Australia's productive relationship with China.

Rio Tinto, which sells 70 per cent of its iron ore to China, is also trying to rebuild its relationship with Beijing. Three days before the trial of its employees began, the company announced plans to take Chinalco as a partner to develop an iron ore mine in the African state of Guinea. Speaking in Beijing, Rio Tinto's chief executive Tom Albanese said he hoped Chinalco's agreement to invest US$1.35 billion in the Guinea joint venture would be a model for other Chinese partnerships.

Thanks to its A$22 billion in iron ore exports to China, Australia was one of the few major economies to escape a recession during the credit crackup.

"China is giving us the ride of our lives," says Colin Barnett, premier of Western Australia. "There are risks and uncertainties, but it's a ride we have got to take."

The Foreign Investment Review Board has approved the vast majority of the Chinese deals for small Australian mining outfits. "The Chinese Government asks its companies to acquire strategic natural resources," says Deng Qilin, general manager of Wuhan Iron & Steel, which invested in two small Australian mining companies in 2008. "We are not saying we must take a controlling stake. We like any form of investment so long as we get the resources."

Last year state-owned Hunan Valin Iron & Steel Group paid A$1.3 billion for a 17.3 per cent stake in Fortescue Metals Group. The company was founded in 2003 by Andrew "Twiggy" Forrest, who grew up on an Outback cattle ranch as the great-grandnephew of a 19th-century Western Australian explorer and state premier.

Perth-based Fortescue, which makes almost all of its revenue from exports to China, earned A$508 million in the year ended last June. Forrest's worth grew to at least A$4.7 billion as his company's shares soared 1200 per cent in the five years from March 2005, giving it a market cap of A$14.8 billion. Fortescue shares increased almost 10 times faster than Rio Tinto's and eight times more than BHP's in that five-year span.

Western investors have made many millions on the Chinese-backed companies. In 2006, New York-based Leucadia National paid US$452 million for a stake of about 10 per cent in Fortescue and the rights to 4 per cent of revenue from two mines until 2019.

Although this year Leucadia reduced its stake to 8 per cent to take some profit, the value of its investment more than doubled.

Paul Kopejtka has both battled and collaborated with Chinese investors. A coalminer's son from Western Australia, Kopejtka got a chemical engineering degree from Perth's Curtin University before founding Murchison Metals in 2004 and selling shares a year later. Last year Sinosteel, China's biggest iron ore trader, outflanked Murchison in its bid to buy Midwest Corp. Sinosteel paid A$1.4 billion in a hostile takeover of Midwest.

Sinosteel has also taken a 5.5 per cent stake in Murchison and will use rail and a port that the Australian company is building to ship iron ore to China.

"It's like a big chessboard, and everyone is jockeying for position," says Kopejtka, who aspires to become a billionaire. Shares of Perth-based Murchison have soared 10-fold to A$2.10 since March 2005, making Kopejtka worth about A$50 million.

Australia is China's top supplier of iron ore, providing it with 43 per cent of its imports, according to data compiled by Bloomberg. BHP and Rio Tinto control more than 80 per cent of the Australia-China iron ore trade.

In 2007 BHP launched a takeover bid for Rio Tinto, but abandoned the deal a year later as commodity prices began their plunge. Beijing officials denounced the planned takeover in state-controlled media as an attempt to create a price-fixing monopoly.

Iron ore spot prices more than doubled to US$147.50 a metric tonne on March 25 from a year earlier, according to the Steel Index, and have risen since, to over US$160.

BHP and Rio Tinto, which have publicly denied they are trying to inflate prices, declined to comment for this article.

Beijing intensified its own dealmaking for Australian companies in 2008 when state-controlled Chinalco and Alcoa agreed to pay US$14.5 billion for a 9 per cent stake in Rio Tinto. The company accepted and then last June said no to an extra US$19.5 billion investment from Chinalco after protests from shareholders and politicians. The politicians claimed Chinalco wouldn't be an asset to the mining industry because it would act in the interests of Beijing's communist rulers.

Instead, Rio returned to its former suitor, BHP, to form an iron ore joint venture. By combining mines, rails, ports and workforces in Western Australia's Pilbara region, the two companies say they will save US$10 billion.

The agreement will concentrate power in the iron ore market and result in higher prices for customers, says Brussels-based steel industry group Eurofer. The European Union said in January it was investigating whether the deal curbs competition.

BHP and Rio Tinto have said their iron ore will continue to be marketed separately.

In July, four weeks after the deal was announced, the four Rio Tinto employees were arrested in Shanghai. While China's Foreign Minister Yang Jiechi said the arrests weren't related to Rio Tinto's rejection of the Chinalco investment, some Australians aren't so sure.

"I don't think it's coincidental," says Geoffrey Garrett, professor of political science at the University of Sydney.

Meanwhile, Chinese-backed companies in Western Australia are ramping up operations. In Fortescue's 2009 annual report to shareholders, Forrest wrote that his company was battling against BHP and Rio Tinto on their home mining turf of the Pilbara, a northern region possessing the nation's richest iron ore deposits.

"Your company has shattered the iron ore duopoly which existed in the Pilbara for many decades and firmly established itself as a vital alternative supplier of iron ore," wrote Forrest.

Forrest said in March he was studying plans to raise as much as US$8.9 billion to help lift annual production from the present 40 million tonnes to an eventual 260 million tonnes. Four days later, Forrest told a conference in Perth Fortescue was prepared to sell stakes of more than 50 per cent in some of its lower grade iron ore projects in Western Australia to overseas steel mills.

While Fortescue posted sales of A$1.83 billion in the year to last June - its first full year of mining - smaller companies face huge hurdles in competing against the mining giants. BHP and Rio Tinto, who trace their history back more than 100 years, occupy the best mining leases in the Pilbara.

The hematite ore they mine needs only to be crushed before being loaded on to trains and ships. When the ore gets to China, it can often be fed directly into steelmaking furnaces without processing.

Smaller companies are at a disadvantage because many of the remaining mining leases are for lower-grade ore, including magnetite. It contains less iron than hematite and needs more costly processing.

Citic Pacific, the Hong Kong unit of China's biggest state-owned investment company, paid US$200 million to Australian entrepreneur Clive Palmer for the rights to mine 1 billion metric tonnes of magnetite. Citic is now spending a total of US$4 billion on several projects, including a 450MW power station to process 28 million tonnes of the iron ore annually. The company also has to construct a 51 billion litre desalination plant and a 25km slurry pipeline to transport the processed ore from the mills to a custom-built port.

BHP and Rio Tinto have another advantage: In the Outback, where there are few roads and train tracks, the mining giants built their own railway and port for their exclusive use. Their iron ore is loaded on to separate 2.5km-long trains and freighted 300km to the coast. In 2008 Fortescue became the first of the smaller iron ore mining companies to construct its own railway and port after spending five years and part of A$2.8 billion on the project.

Six Chinese companies and their Australian partners are also setting up operations in the midwestern region, a new, mostly magnetite-mining frontier in Western Australia 1000km south of the Pilbara.

In the midwest, Karara Mining, the joint venture between Perth-based Gindalbie Metals and Anshan Iron & Steel, aims to start mining hematite and magnetite beginning next year.

Dennison Hambling, chief investment officer of Melbourne-based First Samuel, is splitting his bets between the big and small companies. He says First Samuel holds shares in Rio Tinto because, with BHP, it will be dominating iron ore exports to China for years. The firm is also investing in the rise of Perth-based Ferraus, an iron ore company backed by two Chinese state-owned companies that operates in the Pilbara.

"China is positioning itself to play a major role in the next generation of iron ore miners," says Hambling. "In five or 10 years, I don't think Rio Tinto or BHP will be in as commanding a position as they are in now. There will be a fourth and fifth force in mining."

- BLOOMBERG