Fortescue Metals has released a roadmap to eliminating carbon emissions from its Pilbara iron ore operations. The capex required amounts to US$6.2 billion over eight years and is incremental to existing planned capex. This expenditure does not include Fortescue Future Industries’ multiple green hydrogen potential projects beyond FMG’s iron ore operations.
FMG’s announcement is focused on eliminating its Scope 1 and 2 emissions from its Pilbara iron ore operations by 2030. In FY22, FMG disclosed total Scope 1 and 2 emissions of 2.55mt of CO2e and expects this to increase to about 3mt by 2030 on a business as usual basis.
Diesel is the largest contributor to FMG’s emissions with gas a distant second. FMG expects it can save US$3 billion of operating expenditure by 2030, or US$818 million per annum at current market prices of diesel (US$1.00/litre, excluding the A30c/l diesel rebate) and US$4.50/GJ for gas. FMG does not say if there is any contingency or allowance for inflation which brings the company’s claimed >20% IRR into question. It would also avoid the use of Australian Carbon Credit Units (ACCU) currently US$20 per unit. FMG currently uses approximately 700m litres of diesel annually and 15m GJ of gas.
Renewable energy and fleet. The investment plan includes the deployment of 2-3GW of renewable energy and battery generation (US$3.2 billion) and associated transmission and infrastructure. The development of green mining haul trucks and rail (US$1.3 billion) will align with the current fleet replacement life cycle. The haul trucks are to be supplied through a partnership with Liebherr for 120 trucks, with a further 150 trucks to be replaced towards the end of the decade.
Capex plans. FMG’s existing capex program is already large. FY23f capex is being guided to US$2.7-3.1 billion as it reaches the first production of magnetite ore from the Ion Bridge project. Group operational capex is guided to US$1.4-1.6 billion in FY23f. The FY23f capex total includes US$100-200 million of decarbonisation spending, and it is this factor that will grow to a maximum of US$1.5 billion in FY26f and FY27f at the peak of the decarbonisation program.
FFI’s remit goes much further. FMG claims this investment in renewable energy and decarbonisation will generate ‘attractive economic returns’ through energy cost savings and a sharp reduction in carbon offset purchases. But these claims cannot be verified on the information provided. Its target of producing 15mt of green hydrogen by 2030 are nascent at best.
FFI’s remit goes well beyond decarbonising the group’s Pilbara iron ore operations. Dr Forrest has spent the last two years travelling the world accumulating a Pandora’s box of agreements and handshakes for (un-costed) projects that may or may not eventuate.
Investment view
A Victorian-era household elixir promoted as Mrs Winslow’s Soothing Syrup was an indispensable aid to hush bawling babies and teething tots. Unfortunately, it contained morphine and possibly caused more harm than good. Decarbonising FMG’s iron ore operations may be a worthy goal, but it seems the method being applied by FMG could have some severe financial side effects.
Dr Forrest, FMG Executive Chairman, told the AFR that annual spending within the overall US$6.2 billion capex budget would not exceed more than 10% of the earnings generated by FMG’s iron ore business in any given year. For this to be effective, FMG would need to generate annual profits averaging US$7.75 billion for FFI to receive 10% (US$775 million) each year for the next eight years amounting to US$6.2 billion. In the last ten years, FMG has achieved this level of net profit only once, in FY21 (Figure 1) and that was mainly due to the extraordinarily high average realised iron ore price of US$134/dmt.
FFI has already ‘accumulated’ US$1.1 billion of available FMG profits so we assume this may contribute towards the full capex amount specified. FMG is currently allocating 10% of annual net profit to FFI, but there is no barrier to increasing this stipend. Nor does there seem to be much discussion on the risk factors to which FMG might be exposed such as technology (alternatives to hydrogen), the production and transportation of hydrogen, or the economics of producing it.
As the funding requirements grow, FMG is likely to push its dividend payout ratio towards the lower end of its 50-80% range.
FMG’s announcement is once again long on rhetoric, but short on detail despite the brandishing of a smattering of figures. Among many purported benefits, FMG says value will be created by producing a carbon free iron ore product. China is FMG’s only ‘customer’ and it is doubtful Chinese steelmakers would pay a premium for such a product when that country’s attitude to emissions reduction is risible.
Risks To Investment View
FMG’s earnings are highly sensitive to the iron ore price. Any changes to demand, production, transportation or saleability of FMG’s production would be negative for earnings. The funding of FFI projects presents a major risk to earnings given the expected size and scale of the project list. Green hydrogen may not be cost effective as initially thought.
Recommendation
We have retained our Hold recommendation.
FIGURE 1: FMG greenhouse gas emissions (t CO2e)
FIGURE 2: FMG net profit, average iron ore price
FIGURE 3: Iron ore 62% Fe, CFR China (NYM $/mt)
