Rio Tinto Digs Deeper Into Africa

Rio Tinto has prided itself on the fact that more than 80% of its assets are in OECD countries. So its $3.9 billion deal last month to buy Australian-listed Riversdale Mining, whose principal assets are in Mozambique, represents a strategic shift for the global mining giant.

Riversdale will double Rio Tinto’s African gross assets, catapulting that continent past the U.S. in importance for Rio Tinto. Following on the heels of Rio Tinto’s multibillion-dollar investment in a metals project in Mongolia, the Riversdale acquisition signals the necessity for the global miner take on political risks it has heretofore shunned.

In this case, there are precious few Tier 1 hard coking (metallurgical) coal reserves in the world. Riversdale expects that by 2025 Mozambique will supplant the U.S. as the world’s second largest exporter of premium hard coking coal used for steelmaking (with a current global market share of 17%) after Australia (64%).

Riversdale didn’t have the financial wherewithal to bring the African reserves to production, however. As with the similarly sized Mongolian Oyu Tolgoi copper-gold mine (development cost in the neighborhood of $5 billion), where Rio Tinto stepped in to develop a site originally discovered by Canada’s Ivanhoe Mines, Rio Tinto brings operating credibility, depth of experience and marketing resources as well as financial backing.

Like Mongolia, Mozambique will need to raise its technical and educational levels to attain industrial competency on par with developed countries in order to attract foreign investments and know-how for further economic development and political stability.

The Riversdale acquisition has the potential to more than double Rio Tinto’s current managed hard coking coal production to more than 30 million tons per year post-2020, according to a Rio Tinto spokesman. But developing the Mozambique mines will be no mean feat.

There is significant credit risk, as reflected in the country’s B+ S&P sovereign bond rating, one notch below Mongolia’s BB– and well into non-investment grade. While the country has recovered from a protracted and brutal civil war that stretched from 1977 to 1992, Mozambique remains dependent on foreign assistance for more than half of its annual budget and the majority of the population is below the poverty line. With the majority of coking coal exploration activity taking place after 2004, the country’s short track record of dealing with foreign mineral development and socio-economic underdevelopment contributes to political risk.

In a project financing (though perhaps premature), assuming a 30% equity and 70% debt component and 10-year loan repayment, margins over Libor could easily exceed 400 basis points and the assistance of international development banks and export credit agencies would be needed alongside commercial bank financing to mitigate political risk and add project lending capacity. Still, Rio Tinto has moved at an opportune moment. As a recent Credit Suisse assessment pointed out, other players are busy minding their own shops and are unlikely to top Rio Tinto’s deal for Riversdale.

Tata Steel (24% owner of Riversdale) has its own balance sheet leverage issues and its managing director Hemant Nerurkar has stated that he is interested in securing coking coal for Tata’s own steel operations rather than investing in Riversdale for its own sake.

Brazil’s Cia. Siderurgica Nacional (CSA, a 16% owner of Riversdale) is probably interested primarily in securing coking coal raw material supplies for its steelmaking.

Anglo American has just deleveraged its balance sheet and has the least debt headroom of the major miners. Xstrata has more than $8 billion in undrawn credit facilities, but has a smaller position in coking coal and is more likely to bid for the Drummond thermal coal assets in Colombia. Brazil’s Vale is focused on building its own Mozambique coking coal project and would probably welcome Rio Tinto investment in the country because Rio will be better able to share the costs of the necessary infrastructure expansions.

Not only did Rio Tinto strike while competitors’ hands were tied. It inked the deal just before floods in Australia cut off much production there and sent coking coal prices soaring. Prices have now hit $250 a ton and could reach $300 when the next quarterly contracts are priced, up from $170 in 2009 and $190 in 2010.

Good timing all around on the part of Rio Tinto, though it will be a challenge to build sufficient infrastructure to realize Mozambique’s coal potential and to obtain the debt to finance the project.