November 2013

Quebec’s iron-clad bond with China

Both parties in iron ore business for the long haul

By Pierrick Blin and Antoine Dion-Ortega

China’s economy should continue to cool in 2013, with predictions from PricewaterhouseCoopers (PwC) indicating seven or eight per cent growth for the year. But while Chinese investors are growing more cautious that does not mean that demand for iron ore will decline, says Ari Van Assche, associate professor at HEC Montreal and an expert on the Chinese economy. “China’s economy will keep on slowing down in the coming years, but economic growth does not necessarily have an impact on foreign direct investment (FDI),” he points out. “Since Chinese companies are richer than before, they are going to invest abroad, including in North America.” In the mining sector, the decision to invest in Quebec will depend mostly on the health of the iron ore industry rather than on China itself, he adds: “As long as the industry is doing fine, they will invest. We should not focus solely on growth.”

In fact, exports to China have been increasing rather than decreasing over the last few years despite the decline in Chinese growth. “There has been an intensification of trade between China, and the rest of the world,” says Michel Leblanc, president and CEO of Montreal’s Board of Trade. “In Quebec, iron ore has clearly been the vehicle for this increase.” In 2008, he recalls, ore from the iron-rich Labrador Trough that runs down northeastern Quebec made up just one per cent of the province’s total exports to China. By 2012, that proportion had soared to 30 per cent. Canadian exports to China increased by 15 per cent in 2012 alone, and are now worth almost $20 billion.

Cyclical by nature

But globally, the end of 2012 and beginning of 2013 were tough for mining companies, and iron ore was no exception, with prices dipping below $100 per tonne in September 2012 – a low not seen since 2009. Steelmakers held back their buys, primarily because they had high inventories of steel, but also because there was some uncertainty on the credit market, says Patricia Persico, director of global communications at Cliffs Natural Resources. The steep decline in demand forced many mining companies to write off billions in assets, with Cliffs itself announcing in January of this year that it would write down $1 billion on its Bloom Lake property.

That is just how the market works, notes Persico, who is confident that demand for iron ore will keep on intensifying, although not as aggressively as in 2011. “We believe growth is still healthy in China,” she says. “As China’s economy transitions from an emerging economy to a mature one, it will still have a need to consume steel, but this demand will be not without volatility in steel consumption and productivity, so there’s going to be a natural volatility in the pricing for steelmaking raw materials such as iron ore.”

“We must stay the course,” Leblanc insists. “We are obviously experiencing a slowdown, some decisions are being delayed, but the demand of the [Chinese] middle class will continue in the future. We should be wary of pessimism.”

Dealing with a more savvy China

In April 2012, Zhou Xiaochuan, governor of the Peoples’ Bank of China, spoke out against the poor understanding Chinese investors had of the investment environment, legal systems and financial markets of the countries they invested in at the Boao Forum for Asia. “This will take some time to improve,” he said, yet this year those same investors have been hard at work applying lessons learned.

“China has had some problems with return on some of their investments abroad,” says Nochane Rousseau, leader of the mining industry for Quebec at PwC. “They realized that they might not have all the skills required to make these business decisions, so they are now more careful in their investments. We also noticed that they are more active shareholders and that they stay involved in the projects’ management.”

Though it is not in iron ore, the Nunavik Nickel project, owned by Canadian Royalties, is probably the best example of the new Chinese stance. Jilin Jien Nickel bought Canadian Royalties in 2010 through its Canadian subsidiary, but the project faces financial problems that the China Development Bank, which funded it initially, now refuses to take on. “We would tend to expect that the Chinese banks will bail them out, but that is just not happening,” says Rousseau, adding Canadians should not expect China to save the day. “Since they will be more cautious in their investment, there will be fewer projects chosen,” he notes.

Canadians have had good reason to expect a lot from China in the past. Quebec in particular owes a lot to Chinese investments, which are foremost among foreign investors. “In the last few years, many major mining projects in Quebec have been either developed or advanced thanks to Chinese investment,” says Rousseau.

That was certainly the case for the Bloom Lake project, into which Wuhan Iron and Steel Corp. (Wisco) invested $240 million in 2009, taking a 20 per cent interest in Consolidated Thompson – which owned the project at the time – and signing up for a 50 per cent off-take agreement. It was an investment that certainly did not go unnoticed by Cliffs, which took over Consolidated Thompson two years later for $4.9 billion.

“We wanted to grow within China, and more generally the Asian market, and Consolidated Thompson was very attractive for us at the time,” says Persico, who notes that their partner in Bloom Lake is the fifth largest steel producer globally. All seven million tonnes of iron ore produced at Bloom Lake is exported to the Asian market.

Wisco has also invested $91 million in the Otelnuk Lake project, which Adriana Resources is currently advancing through its feasibility stage, some 170 kilometres north of Schefferville.

Even though iron ore from Quebec costs up to twice as much as Australian ore, Chinese steelmakers will hold on to these strategic investments because they need to secure diversity of supply rather than depend on a handful of mining multinationals, says Van Assche. Also, Quebec’s deposits are high-quality, Rousseau notes, but less concentrated, meaning projects often need to include an extra concentration step in their design.

In any case, Cliffs is confident that the Labrador Trough will continue to hold interest for foreign investors. “The advantage in the Trough is that you have an established infrastructure, so companies are attracted to that rail, to that port,” says Persico. “You don’t have to build that.”

For the moment, Cliffs has put aside its expansion project at Bloom Lake that would have doubled the output of the mine to focus on the stability of the original project and satisfy its investors. “We have no timetable for the Phase 2 expansion,” Persico admits. “We will probably make some determination within either this year or early next year on a timeline. Right now, we are putting that on hold. We are being much more prudent with our capital investment. We have had to pull back a little bit in the last six months.”

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