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How Mozambique killed coal at Rio

09 November 2017

Last week's fraud charge instigation over Rio Tinto's $3bn Mozambique fiasco pulsates an edgy echo from a seminal moment in recent coal history.

The charges, brought by the US Securities and Exchange Commission (SEC), concern events more than half a decade ago.

But they have cast a long shadow, still informing much of Rio's modern corporate strategy.

It's now plain that the Mozambique experience killed coal at Rio. But the whole truth is much worse. The Mozambique debacle was the single most potent harbinger of a fundamental change in the entire resource sector.

Rio's Mozambique meltdown became emblematic of a debt fuelled, high-priced acquisition binge that discredited, and even ruined, many commodities majors earlier this decade.

The era chastened Rio, hobbling the expansion ethos once deeply embedded in its DNA, ushering in an era of severe corporate parsimony.

Ripples spread and growth was quickly rendered anathema throughout the commodities sector. Inward focus, cost-cuts and capital returns became mandatory for any chance at investor approval.

Markets are still rewarding this penny-pinching today. It's barely an exaggeration to say the more miserly a resource company sounds, the more investors like its shares - especially after some recent near-death experiences, several of them in coal.

With interest rates and inflation near record lows, this is a curious phenomenon, reflecting extreme short-term focus.

It's typified by current private equity pressure for the world's biggest metallurgical (met) shipper, BHP Billiton, to divest assets.

But should not smart management, having slashed debt, instead now be focused on ploughing cheap funds into their next stage of asset development?

The polar opposite seems to be continuing at Rio, whatever the SEC outcome, predestining the company to rank as the only quoted world commodities major without coal exposure.

It all started with a fateful filing late in 2010, sporting plenty of Rio bravado that's worth reiterating for the lessons it holds.

Announcing a near A$4bn ($3.1bn) all-cash offer for Riversdale Mining, which held Benga and other met prospects in Mozambique, Rio declared the move to be in line with its strategy of developing large long-term cost-competitive businesses.

"Rio Tinto's extensive experience in infrastructure and large project development combined with our significant financial capacity means that we are well-placed to take Riversdale's asset base through its next phase of development," the 2010 statement said.

"We believe Rio Tinto is one of the few groups in the world with the capabilities, values and incentives to develop the project quickly."

A subsequent 2012 statement marking Rio's first coal shipment from Mozambique described it as "the first step toward our aim of becoming a significant supplier of hard coking coal in the seaborne market."

At the time, Rio quietly talked of Mozambique's ability to triple its met capacity of around 10 mt, but the Mozambique resource never yielded more than a fraction of this potential.

Just months later, Rio's chairman dubbed the Mozambique events "unacceptable" and wrote off almost the entire investment as part of a $14bn impairment package also heavily impacting the company's Alcan aluminium arm.

Small wonder that then chief executive, Tom Albanese, stepped down with the debacle also claiming the company's Energy chief, Doug Ritchie, who led the Mozambique campaign.

Rio last week maintained it would "vigorously defend" the SEC charges, filed in a New York court, alleging a slew of corporate breaches by the company, Albanese and former CFO, Guy Elliott.

Well may Rio defend its legal rights. Much harder to defend, though, are the Mozambique incident's trashing of shareholder value plus the company's hard-won resource credentials.

As a source close to Rio said: "The regulators aren't looking at the merit of the deal, but how it was handled in the accounts," but added that the departures from Rio's top echelons "reflect the company view of the success, or otherwise, of the transaction".

Rio can probably never fully justify how it failed, as one of the world's leading minerals developers, to identify serious flaws in Mozambique's met resources and logistics.

Coal has been 'on the nose' at Rio ever since. Once a corporate jewel and career maker, Rio's coal division, an important formative operation, was progressively stripped of independent existence.

Following more revamping last year, Rio coal was humiliatingly subsumed into a division known as 'Energy and Minerals,' including such disparate interests as borates, salt and titanium.

Then most of it was jettisoned when the company's industry leading thermal and semi-soft interests were sold to Yancoal and Glencore for around $2.5bn earlier this year. Rio's met coal division is now being offered in a formal auction process.

It could all have been so different had Rio's approach lived up to its own high standards.

Doubtless doubly galling to Rio is that arch-rival Vale is finally making a go of an almost parallel met coal investment in Mozambique - mostly through patience, persistence and a low-key entry strategy.

Not alone

As indicated, Rio is far from the only resource major to suffer from bad acquisition strategies. In the US alone, ill-advised takeovers and other mistakes helped put Peabody, Alpha, Arch and Walter into bankruptcy while UK-based Anglo American tried unsuccessfully to quit the industry last year.

But the SEC charges singled out Rio, in allegations that cut deep for a company holding itself as a resource industry pillar. True to its tough reputation, the US regulator did not hold back.

In a detailed filing, the SEC said its charges involved "fraud for inflating the value of coal assets" by Rio and its executives on its Mozambique foray. The filing said those charged failed to follow accounting standards to accurately value assets.

"Instead, as the project began to suffer one setback after another resulting in the rapid decline in the value of the coal assets, they sought to hide or delay disclosure of the nature and extent of the adverse developments," the SEC said.

"Rio and its top executives allegedly failed to come clean about an unsuccessful deal that was made under their watch. They tried to save their own careers at the expense of investors by hiding the truth.

The complaint alleges that after already impairing Alcan twice, Albanese and Elliott knew that publicly disclosing its second failure and rapidly declining value would call into question their ability to pursue the core of Rio Tinto's business model.

"Instead, they concealed the adverse developments, allowing Rio Tinto to release misleading financial statements days before a series of US debt offerings.

"Rio Tinto raised $5.5bn from US investors, approximately $3bn of which was raised after May 2012 when executives at Rio Tinto Coal Mozambique had already told Albanese and Elliott that the subsidiary was likely worth negative $680m," it said.

Rio Tinto responded last week with a statement describing the SEC case as "unwarranted," asserting it would be rejected by the court system.

But Rio was also forced, in the same statement, to acknowledge a settlement with the UK Financial Conduct Authority involving a $36.4m fine over Mozambique accounting treatment.

The Rio statement also said Australian regulators were examining the case and this week a class action was filed in a US court citing Rio's Mozambique statements. The company faces adverse headlines for some time yet.

This story was originally published in IHS McCloskey Coal report which makes up part of the 'Global Coal News and Analysis' capability.

Posted 9 November 2017

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