Did the World Bank Just Kill Rio Tinto's Massive Simandou Iron Ore Project?

By Markets Fool.com

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Image source: Getty Images.

Rio Tinto's (NYSE: RIO) massive Simandou iron ore project in West Africa just had another naildriven into its coffin after the World Bank announced it was forcing the miner to buy out its stake in the project.

Simandou may have the potential to completely upend and alter the look of the iron ore market were it ever to come online, but industry economics make it clear it's not going to see the light of day for a very long time.

A mountain-sized opportunity

The project is located deep in the heart of the Simandou mountains in the Republic of Guinea, and though it holds vast stores of iron ore that have been estimated at about $50 billion, the cost to develop the mine has become untenable as commodity prices, including iron ore, have plunged.

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Although the import price of 62% iron content ore at the Chinese port of Tianjin has staged a rally this year, surging 32% to reach some $56 per tonne despite expectations of further declines in Chinese steelmaking after a decade of growth, prices still remain well below the peaks hit back in early 2011 when they topped out just north of $191 a tonne.

There remains a supply glut that isn't expected to dissipate anytime soon. This past summer analysts at Morgan Stanley forecast a supply glut of 33.4 million tonnes this year before rising to almost 100 million tonnes by 2018 as new projects come online. BHP Billiton (NYSE: BHP) expects the situation to remain out of equilibrium for at least another decade.

The western Australia Pilbara mining region is rich with ore and the world-class Roy Hill project is on track to ramp up to 55 million tons annually by the end of the year. Vale (NYSE: VALE) has also said it expects its S11D expansion project at Carajas in the Brazilian Amazon to begin producing in December and reach full capacity by 2018, with Liberum Capital saying iron suppliers will add some 50 million tons of supply over the next year.

Maybe some other time

All of which explains why Rio Tinto mothballed Simandou. Just weeks after delivering a feasibility report on the giant project, the miner seemingly reversed course and announced it was pulling the plug on it altogether. Yet all along, the odds against developing the project were high.

Image source: Getty Images.

Because of Simandou's remote location, vast and expensive infrastructure needed to be built. Some $20 billion would need to be invested in constructing 80 miles of roadway and 400 miles of railway because the government wanted its own ports used for shipping the ore rather than allowing the use of a shorter route to the ports in nearby Liberia. The investment by the World Bank's International Finance Corporation was to help defray the costs. It is exercising its put option on its 4.6% state in the project, which means that Rio Tinto, which owns 46.6% of Simandou, and China's Chinalco, which owns 41.3% -- the government of Guinea owns the remaining 7.1% -- are required to buy out their partner.

If it ever comes to fruition, Simandou would transform Guinea. The country currently depends on its bauxite deposits for most of its revenue, but Simandou alone could double the country's GDP.

The high cost of carrying

That, however, looks like it's a long way away from happening. Rio Tinto swung to a loss earlier this year because of a $1.8 billion writedown on the project, and it has left just $10 million of value related to it on its balance sheet.

Simandou has a troubled history with tales of fraud and bribery checkering its potential. But as the project's owners continue to question the wisdom of moving forward, that may be all the project represents -- potential, with nothing ever coming to fruition.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale. Try any of our Foolish newsletter services free for 30 days. 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.