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Why Rio Tinto Reversed Course on the Massive Simandou Iron Ore Project

By Rich Duprey – Jul 18, 2016 at 5:05PM

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A jewel isn't worth much if you can't get to it.

It's lonely at the top, and that's just the problem for Rio Tinto, as there's barely any way to get to its massive Simandou iron ore resource in Guinea. Image source: Rio Tinto.

Just weeks after delivering feasibility studies in May on its massive Simandou iron ore project in the west African republic of Guinea, Rio Tinto (RIO -0.62%) seemingly reversed course and said it wouldn't be developing the site and was instead putting the project into mothballs. Thought surprising at first glance, Rio has long expressed doubt about being able to bring it to fruition because of the monumental costs involved, and earlier this year it effectively wrote off its entire $2 billion investment in the project, leaving a carrying value on its books of just $10 million.

That's a dramatic reversal of fortune. Simandou is estimated to contain 50 billion tons of iron ore, and when fully developed, it will likely transform Guinea's economy, which is currently dependent upon its large bauxite deposits. But there were a lot of good reasons Rio Tinto finally drove the last nail into Simandou, hurdles that even in the best of times would be difficult to surmount.

Iron ore supply glut

The most obvious reason, of course, is the massive oversupply of iron ore in the market that drove prices to their lowest levels. The benchmark import price of 62% iron ore fines at China's Tianjin port that once traded as high as $160 per ton had fallen all the way to $38 a ton last December. It has since rallied back to near $60 per ton, but analysts don't see any way that can hold.

Analysts at Morgan Stanley forecast a supply glut of 33.4 million tons this year before rising to almost 100 million tons by 2018. The Roy Hill project in the Pilbara region of Western Australia is on track to ramp up to 55 million tons annually by the end of the year, and Vale (VALE) expects its expects its S11D expansion project at Carajas in the Brazilian Amazon to begin producing in December and reach full capacity by 2018.

Lack of infrastructure

Even without the market in oversupply, there are logistical roadblocks. Simandou is located in a remote region of Guinea that requires construction of an entire infrastructure network before the mining project could begin.

That infrastructure alone is estimated to cost some $20 billion, because in addition to 80 miles of roads needing to be built, 400 miles of railway needs constructing to transport the ore from the mine to the coast, plus bridges, tunnels, and ancillary infrastructure such as housing, power-generation facilities, and water systems. Then there's a deepwater port that needs building so Simandou can feed into the seaborne trade. Guinea demands any ore be shipped from its coast, rather than taking the shorter route through Liberia.

Threat of pandemics

The outbreak of the Ebola virus in Guinea and the surrounding area two years ago crippled the mining industry, even if it was temporary. But there was a renewed, if muted, outbreak of the virus again this year, making finding investors willing to come in a foot the tab more difficult.

Rio Tinto owns 46.6% of Simandou, with a consortium of Chinese government-owned enterprises and the World Bank owning the rest. Despite Chinese demand for iron ore that's seemingly insatiable, not even it is willing to step forward.

Ignore the rallies

Iron ore continues to rally. Its price was once again north of $60 per ton again as the Chinese began buying to fill inventories, but there's no indication its sustainable and analysts are expecting another collapse.

As a result, there's simply no need for new iron ore projects to come on the market, and probably not for at least another decade or more. Rio Tinto knows that, which means Simandou's enormous resource riches won't see the light of day anytime soon.

Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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