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Fortescue's clean energy pivot sparks investor questions

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2023-09-11

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In the wake of Fortescue's announcement that its clean power projects would yield only half the returns of its iron ore developments, questions loomed large during investor briefings led by Fortescue boss Mark Hutchinson over the past two weeks. Investors clamored to understand how the company could advocate for fair competition among its mining and energy growth projects while simultaneously accepting lower returns from its energy ventures.

"This was probably most of the discussion with the investors...because they are trying to understand where we are coming from," Hutchinson revealed in a statement on Friday after returning to Perth.

Fortescue's capital allocation strategy has been under intense scrutiny, underscoring the dramatic shift the company has undergone in the past four years. Fortescue, known for its mature iron ore division, has been striving to integrate a clean energy and hydrogen business into its portfolio.

Unlike the established Pilbara iron ore division, which has already recouped its $US10 billion-plus investment in railways, ports, and other infrastructure, the five hydrogen, ammonia, and fertilizer projects Fortescue plans to initiate later this year represent first-generation infrastructure aimed at new, emerging markets.

Comparing these mining and energy growth projects based solely on their internal rate of return would leave the clean energy projects at a significant disadvantage, with projected returns of around 10 percent or less.

However, Hutchinson stressed that the Fortescue board would consider a broader, long-term perspective when deciding whether to invest in these clean energy projects. He emphasized that the shift toward clean energy could add more value to the market compared to the mining sector.

Hutchinson outlined a typical plan for financing the first five clean energy projects, where approximately 60 percent of the construction cost would be funded through non-recourse debt. The remaining 40 percent might be raised by selling equity stakes in the projects to sovereign wealth funds, ranging from 50 percent to 75 percent.

In a bid to reduce risk, Fortescue does not intend to build renewable power assets for these projects but plans to purchase clean power from other sources.

Hutchinson also pointed out that the true value of these initial projects may lie in their future expansion potential or their ability to stimulate demand in emerging markets.

Fortescue's strategy of using the first five projects as a stepping stone for more lucrative clean energy projects in the future echoes the approach taken by other major players like BHP at Canada's Jansen potash project.

The initial projects, including a green hydrogen production and truck fuelling venture in Phoenix, Arizona, and a green hydrogen export project at Brazil's Pecem port, are modular and easily expandable. Hutchinson expressed confidence in the scalability of these projects, suggesting they could pave the way for even larger endeavors.

Fortescue's clean energy endeavors also include retrofitting Incitec Pivot's Gibson Island fertilizer plant in Queensland. This retrofit will enable the plant to produce carbon-free ammonia, setting the stage for a potential second project in the region.

Despite Fortescue's ambitious clean energy plans, there are skeptics regarding the viability of hydrogen as an energy source. Some argue that Australia should prioritize electrification, while others question the feasibility of transporting hydrogen over long distances.

However, Hutchinson remains unwavering in his belief in hydrogen's potential value. He asserts that hydrogen economics are more favorable compared to wind farms.

The recent disclosures about Fortescue's clean energy expansion are crucial for investors, as the company's earnings profile in the clean energy division has been somewhat opaque. This opacity has led some analysts to issue "sell" recommendations on Fortescue shares, expressing uncertainty about the rate of return from the clean energy projects.

Despite these concerns, Fortescue's shares have risen by 15 percent over the past year. This suggests that a substantial portion of investors is either willing to support Fortescue's clean energy ambitions or is willing to tolerate the pivot as long as the iron ore division continues to deliver strong dividends.

Institutional investors like IML are keen to see companies embrace a lower carbon future, but they are cautious about the scale and risk associated with Fortescue's clean energy pivot.

While investing in green hydrogen holds long-term promise, many analysts believe the risk and reward do not align at this stage, especially given the substantial capital requirements and limited financial details available.

Fortescue faces challenging decisions ahead, as its plan to invest close to $US1.2 billion in the clean energy division during a year with expected profits of about $US4.1 billion could impact its dividend payout ratio and debt levels.

As Fortescue forges ahead with its ambitious clean energy journey, the market continues to grapple with uncertainties surrounding the company's transition and its ultimate impact on shareholders and the broader energy landscape.

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