Fortescue says its green energy projects will need to compete with mining returns

Is Fortescue Metals Group retreating from its green energy ambitions, or just dressing up its growing green spending in a less contentious way?

Is Fortescue Metals retreating from its green energy ambitions, or just dressing up its growing green spending in a less contentious way?

On the face of it the decision to force Fortescue’s energy projects to compete for capital with mining, rather than simply bank a budget of 10 per cent of net profit, suggests the company is retreating from Andrew Forrest’s ambition of turning the iron ore major into the world’s biggest energy company.

Fortescue Energy chief executive Mark Hutchinson told analysts on Monday the best of Fortescue’s energy projects target an internal rate of return (IRR) of 10 per cent, or just better.

Fortescue’s board is known to demand an IRR of better than 20 per cent for its mining division before projects are given the green light.

That, as analysts noted on Fortescue’s earnings call on Monday, suggests the green dream is in trouble – if projects don’t stack up, they won’t get built.

Forrest’s biggest critics have long argued that outcome will be the inevitable conclusion of his green ambitions, and that Fortescue Energy (formerly Fortescue Future Industries) will be the first casualty of any turn in the iron ore market – and the wobbles in China’s economy suggest that possibility is looming.

Faced with the choice of saving the world or his dividend stream, they say, Forrest will opt for the latter.

Hutchinson rejected the idea that he could not compete with Fortescue’s metals division for capital, arguing you can’t compare the two on a simple IRR basis.

“Energy projects are different from metals and mining projects. And so the board will have to look at all the risks involved in assessing which is the best place to put the capital,” he said.

Internal to Fortescue the argument seems to be that the swing factor is the longevity of green hydrogen and renewable energy projects.

A new iron ore project, such as Fortescue’s Belinga deposit in Gabon, is limited by the size of the deposit, the mine life, and the market for the commodity. Any mine will eventually run out of ore, and pumping more iron ore into the market will probably drive down the price.

Whereas renewable energy is – in theory, at least – infinite, and the market only grows with supply. Build more hydrogen production capacity and people will buy it, and scale reduces cost without reducing demand.

On that basis a $1bn renewable energy project that delivers a return of $100m a year for 50 years is a better bet than an iron ore play that delivers $200m a year for 20 years.

There is merit in Forrest’s argument that the closer the world gets to civilisation-threatening global warming levels, the better these investments will look.

And the long term is certainly an argument that is mirrored in the investment framework of Fortescue’s peers – particularly those of BHP and Rio over their Pilbara iron ore operations, as stewards of deposits that could still be running in 50 years.

You could quibble about the life cycle projections of renewable energy – no wind or solar farm will have a life equivalent to coal or nuclear plants, and long-life capital investment projections should reflect that.

You could also reduce the same argument to absurdity. On that basis, is a $1bn investment returning $1 a year forever really a better bet for Fortescue shareholders than a 20 per cent return over 20 years?

But another answer may be simpler than that.

The allocation of 10 per cent of net profits to Fortescue Energy is hated in the market, even by shareholders supportive of the company’s green ambitions. It has come up time and again in analyst and investor calls since it was introduced, and will continue to do so.

Fortescue Energy’s 1100 or so employees will still spend $US800m in the current year on operating costs, and there is no sign that spending will slow.

Getting rid of the allocation removes a millstone around Fortescue’s neck. And analysts and investors have no real say at the boardroom table in arguments about the relative merits of iron ore projects or green hydrogen investments – they can sell their shares if they don’t like the outcome, or stay around for the journey.

Because, on current form, there is only one real hurdle any Fortescue investment needs to clear – the support of the executive chairman that owns 36 per cent of the company. Forrest will be proved right or wrong, only time will tell.