The former Rio Tinto adviser who became mining’s Big Short

Henry Steel has made big profits for Odey by betting against his ex-employer’s Oyu Tolgoi mine

by 

Henry Sanderson and Neil Hume

 

Henry Steel used his insight to concoct a massive bet against the Oyu Tolgoi mine in Mongolia

It was only after his acrimonious exit from Rio Tinto that Henry Steel finally visited the giant copper mine beneath the Gobi desert. Gatecrashing an investor trip to Mongolia in late 2016, Mr Steel braved minus 20 degree temperatures before descending 1.3km underground to the Oyu Tolgoi copper mine, one of Rio’s hottest prospects and most expensive projects. Mr Steel, a fast-talking Englishman who was educated at Eton College and Oxford university, did not make a positive impression on all his fellow travellers. At one point in the trip he was chastised by Robert Friedland, the Canadian mining billionaire, for asking too many questions. “It’s like chewing on tin foil listening to him,” said Mr Friedland, who discovered Oyu Tolgoi in 2001 and later sold it to Rio. Although he had never laid eyes on the mine before, Mr Steel, who is now 30, had spent a lot of time thinking about it. Employed as a “special adviser” to Rio in 2013, he wrote a thesis on Oyu Tolgoi, as part of a PhD sponsored by the company.

The dissertation did not turn out as Rio had expected. According to a copy seen by the Financial Times, it concluded that the Mongolian government’s 34 per cent stake in the project was essentially worthless. Mr Steel argued that the country would not receive any benefits until it had first paid off a loan from Rio to finance its share of the construction expenses — which would take at least 20 years. The paper suggested that Mongolia would be better off having an equity share not in the project-level entity but in Rio Tinto itself, enabling the country to receive dividends immediately. Not only had Rio paid for a paper that criticised its own project, the document was widely circulated, including to competitors such as Glencore and Sir Mick Davis, the former head of Xstrata. Mr Steel never received his PhD from France’s EDHEC Business School and the paper was never published. Instead, he left the company soon after. Mr Steel declined to comment on the paper.

“He had ideas above his station,” one person close to the company said. “He trucks himself as being ex-Rio and having insights but that seems slightly unethical to me.” That was not the view of Crispin Odey. The London-based hedge fund manager, who hired Mr Steel as an analyst in 2015, said: “One of the fun things about Odey is we have quite a lot of people who have an industrial background as well. They’ve worked in the industries they look after. And I think that gives us great insight into the industries.” Mr Steel decided to use his insight in a particular way: he concocted a massive bet against the Oyu Tolgoi mine. Two-thirds of the mine is owned by Canadian-listed Turquoise Hill, which runs it on behalf of Rio. In turn, Rio owns a majority 50.1 per cent stake in Turquoise Hill. (One-third is owned by a Mongolian state-owned company.) So far no heads have rolled Henry Steel Odey’s short position has paid off, spectacularly. Last Monday Rio issued a surprise warning to investors, bracing them for further delays and additional costs of as much as $1.9bn on the $5.3bn project. Shares in Turquoise Hill fell 40 per cent on Monday to their lowest level since 2001, generating more than $50m of profit for Odey.

“It’s definitely been one of Henry’s best trades,” said Mr Odey, who promoted Mr Steel to portfolio manager in March. Last week, a second big bet bore fruit after Canadian gold mining company Barrick Gold agreed to increase its offer for Tanzania-based gold miner Acacia Mining. Mr Steel, who oversaw Odey’s purchase of a 2 per cent stake in Acacia, joined other shareholders in opposing vigorously Barrick’s initial offer in May, holding out for a higher price. On Friday Barrick, led by Mark Bristow, improved the deal. Shares in Acacia promptly surged 19 per cent. The Rio bet is more personal. To Mr Steel, the mishaps at the mine point to deeper failings under chief executive Jean-Sébastien Jacques, who is closely associated with Oyu Tolgoi. Not only did Mr Jacques pull together the financing for the project when he was head of Rio’s copper business, he also ended a potentially damaging stand-off with the Mongolian government. “It will be fascinating to see who the Rio Tinto board decides to hold accountable for this,” said Mr Steel. A spokesman for Rio declined to comment. Oyu Tolgoi is Rio’s most important growth project and is also critical for Mongolia’s economy. It is set to be the world’s third largest copper mine by 2027, producing more than 500,000 tonnes a year of the metal. Yet its development has been hampered by delays and controversy in Mongolia, where two former prime ministers and one former finance minister have been arrested on allegations of possible abuse of power related to the project. Last week analysts at UBS called Oyu Tolgoi Rio’s “Achilles heel”.

Delays to large underground mining projects are not uncommon. Rio is using a mining method called block caving, which is technically challenging but also one of the most cost-effective methods of mining ore from deep below the ground. For this method to work, weak and fractured rock needs to collapse under pressure from gravity. “It is one of the most technically complex underground mine constructions in the world, in one of the most remote locations,” Turquoise Hill’s chief executive Ulf Quellmann told analysts and investors this week.

Mr Steel believes there are additional costs to the mine that are not included, even in Rio’s increased estimate, including expenses from a new power plant that Rio has pledged to build, as well as interest charges and working capital requirements. Turquoise Hill will need to issue equity at a heavily discounted price to cover the shortfall, he believes. He also believes opposition within Mongolia to the mine will continue to rise and the country will scrap an agreement with Rio over the underground expansion of the mine. In April, a parliamentary working group in Mongolia recommended that the 2015 deal orchestrated by Mr Jacques to finance the underground expansion should be revoked. There have been conflicting signals from Ulan Bator about the contracts that underpin the underground development. In April, the minister for Mining and Heavy Industry, Sumiyabazar Dolgorsuren, said the government “won’t terminate” the agreements because it could scupper plans to list the country’s biggest coal mine. But in more recent comments Mr Dolgorsuren said some of the contracts should be “amended”. Turquoise has said all options for future funding are on the table. Rio and Turquoise declined to comment on Mr Steel’s assertion that there were additional costs. Shares in Turquoise Hill have fallen almost 80 per cent over the past year, hurting shareholders such as California-based fund SailingStone Capital but eliciting little sympathy from Mr Steel. “So far no heads have rolled,” he said.

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Rio delivers dividends despite Mongolia delays The underground expansion of Rio Tinto’s giant copper mine in Mongolia’s Gobi desert is the project most closely associated with its hard-charging chief executive Jean-Sébastien Jacques, writes Neil Hume.  

As head of Rio’s copper division, the 47-year-old French-born executive helped pull together the $4.4bn funding package for Oyu Tolgoi in 2015, which saw 20 lenders, including the European Bank for Reconstruction and Development, back the project. 

 However, when the Anglo-Australian miner announced a big delay and cost overrun last week it was left to Stephen McIntosh, head of Rio’s Growth and Innovation unit, to try to explain what had gone wrong. 

 “The ground conditions are more challenging than expected and we are having to review our mine plan and consider a number of options,” said Mr McIntosh. 

 The setback at Oyu Tolgoi is the second to hit the company in the past month. In June Rio cut production guidance for its flagship iron ore business, citing “operational challenges” at one of its main mining hubs in the Pilbara region of Western Australia. Rio said it would now produce 320m to 330m tonnes of the steelmaking ingredient, against an earlier forecast of 333m to 343m. 

 For many analysts and investors, the iron ore downgrade was more surprising, puzzling and damaging than Rio’s problems in the Gobi desert. 

 Rio is widely regarded as one of the best operators in the industry and has been mining iron ore in the Pilbara for decades. As such, it should not be struggling with issues like waste material and pit sequencing, say analysts. Mining copper from an ore body the size of Manhattan 1.3km below the surface of a remote desert is another challenge entirely. 

 Still, the two blows have not dented Rio’s share price, which has risen 28 per cent this year, outpacing peers including Anglo American, BHP and Glencore. For that Mr Jacques has a runaway iron ore price to be thankful for. Aided by a string of supply disruptions and record steel production in China, the steelmaking commodity has jumped 65 per cent to a five-year high above $120 a tonne. At that level Rio is making $100 for every tonne it digs out of the ground. 

 That is fuelling expectations of another bumper cash return when Rio files interim results on August 1. Since Mr Jacques took the helm in 2016, promising to boost shareholder returns, the company has paid out almost $30bn to shareholders. 

 “While Rio is having some operational issues, the big story is iron ore prices,” said Christopher LaFemina, analyst at Jefferies. “We believe a 12-month period of iron ore prices averaging near or above $100 a tonne will lead to continued outperformance for Rio shares.”

Source:Financial Times