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Work on one of six production lines at Citic Pacific's Sino Iron project near Karratha is complete. Photo: Bloomberg

MCC blows budget on iron ore mine, again

Construction firm tells miner Citic Pacific that a new financial plan agreed to a year ago is still not enough to get Australian project on track

Citic

It's happened again. Citic Pacific, the state-backed conglomerate building Australia's largest magnetite iron ore project, and its contractor Metallurgical Corporation of China (MCC), disappointed the market last week by announcing that the project is over budget for a fourth time.

The size of the final cost-overrun of the Sino Iron project in Western Australia is uncertain, as only one production line is finished and the second line is due to come on stream in May.

Another four production lines need to be installed by the end of the year to make their commissioning target of early next year. While this will be managed by Citic Pacific, units of MCC will be invited to bid for the work. Ancillary infrastructure common to all six lines has been finished.

MCC, the engineering, procurement and construction contractor, said last Wednesday that the US$3.4 billion budget agreed with Citic Pacific just over a year ago was insufficient, and MCC had advanced the project US$858 million to finish it.

But instead of talking directly to Citic Pacific, MCC said that "for the purpose of controlling project costs and pressing ahead with the project" it would negotiate with parent Citic Group.

Citic Group agreed in a written statement that the construction cost up to completion of the second line should be kept under US$4.36 billion, MCC said.

MCC added that a third party had been engaged to audit the total costs actually incurred by MCC, to come up with the final contract value. The third party was not named.

Citic Pacific said it was not party to, and so not bound by, the statement issued by Citic Group. But it plans to negotiate with MCC to resolve unsettled issues when the project is finished, including penalty payments MCC owes for completion delays.

The magnitude of the latest cost overrun is a bit of a surprise

"The magnitude of the latest cost overrun is a bit of a surprise," a brokerage analyst covering Citic Pacific said. "It seems like Citic Pacific does not want to negotiate with MCC yet, it wants to do so only after the project is completed."

He said that given the latest cost blowout, there was a risk that the total project cost would exceed the US$10 billion ceiling Citic Pacific targeted last year. Citic Pacific previously attributed the overruns to surging material and labour expenses, and the rising Australian dollar, as well as miscalculations by MCC.

MCC chairman Jing Tianliang said last year that some of the miscalculations were due to differences between Australian and mainland project management procedures, and Australian labour rules that required MCC's mainland technical staff to be proficient in English and meet specific qualifications.

"MCC and Citic Pacific cannot be blamed entirely, Australian mining giants like Rio Tinto have also seen cost blowouts due to market forces," the analyst said. "But they have been deferring their new projects, whereas Citic Pacific is under pressure to finish the entire project."

If Citic Pacific did not build the entire project, it would not have sufficient operating scale to spread the fixed costs and lower the production cost for each tonne of output to ensure profitability, he added.

A Citic research report last November estimated Citic Pacific's project to be profitable only at ore prices of over US$108 a tonne, and could lose money in the long term since ore prices could fall to US$80 a tonne on oversupply.

According to a Morgan Stanley research note, MCC is contractually bound to pay Citic Pacific US$5 million per day of delay, which the brokerage estimated to come to around US$400 million.

Assuming Citic Pacific agreed to a cost increase of US$858 million from the US$3.4 billion budget, the Morgan Stanley analysts said the project's net asset value would be cut by 13 per cent.

Even if MCC paid the estimated penalty of US$400 million, the project's value would be reduced by 7 per cent, they added.

They estimated the project's loss before interest and tax to be HK$1.8 billion this year, assuming it met its output target of two million tonnes and paid US$190 million in royalties.

When MCC was first contracted to build the project six years ago, the engineering, procurement and construction budget was US$1.1 billion.

It bought a 20 per cent stake in the project in 2007 for US$448 million.

When fully utilised, the project's six production lines will be able to produce 24 million tonnes of ore, a third of which is expected to serve Citic Pacific's own steel mills, and the rest for other mainland steel mills.

This article appeared in the South China Morning Post print edition as: MCC blows budget on iron ore mine - again
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