May 18, 2015

How is the Fortescue board of directors structured? What is Fortescue’s reputation regarding corporate governance practice?

FORTESCUE METALS GROUP LIMITED

Dr Tim O’Shannassy, Graduate School of Business and Law, RMIT University

Recent media discussion has speculated on the end of the mining boom in Australia. In mid 2012, the Federal Minister for Resources and Energy Martin Ferguson was reported in the media as suggesting that the mining boom is over.¹ The Australian economy, the mining industry, and mining states such as Western Australia and Queensland have benefited greatly from the strength of the Chinese economy before, during and after the global financial crisis (GFC). As the Chinese economy modernises and grows, its already substantial demand for Australian iron ore and coal has also increased. The Chinese government remains committed to growing its middle class, moving a further 600 million people from their rural lifestyles into urban dwellings.² This all requires access to iron ore and coal to help build infrastructure for cities and suburbs. Fortescue Metals Group Limited (Fortescue), located in the Pilbara region of Western Australia, is ideally located to service Chinese demand for iron ore by shipment.³ Reflecting this, employment opportunities and royalty revenues for the resource-rich Australian states have been strong.

The growth of the Fortescue business and the evolution of its management and board of directors since its start-up in 2003 have been rapid. In only nine years Fortescue joined the Australian Securities Exchange (ASX) Top 50; spent or committed to spending A$15 billion in resource projects; completed its first major mine, rail line and port development; and, in 2011, exported 40 million tonnes of iron ore.⁴ Fortescue has ambitious plans for future capital expenditure and growth. The challenge for charismatic Fortescue founder and chairman

Andrew ‘Twiggy’ Forrest and chief executive officer Neville Power is to continue to drive large-scale project financing, project implementation and iron ore export growth through a

period of global economic uncertainty.⁵ Key personalities

Iron ore magnate Andrew ‘Twiggy’ Forrest has been the key person behind the creation of Fortescue and, in 2010, he was Australia’s richest man.⁶ Forrest’s professional background includes extensive experience as a company director in the mining industry. Forrest is a specialist in large-scale project finance and the execution of large scale mining projects. He is supported at Fortescue by chief executive officer Neville Power. Power joined Fortescue in September 2011 after an executive career in construction with Thiess Pty Ltd and in the steel industry with Smorgon Steel Group. Deputy chairman Herb Elliot is famous for convincingly winning the Olympic 1500 metre track event at the Rome Olympics in 1960 and is considered to be an Australian sporting icon. He has had a successful career in business after athletics — including directorships at ASX Top 100 companies Pacific Dunlop

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Limited and Ansell Limited. The Fortescue Port Hedland port facility is named after him. Fortescue’s chief financial officer Stephen Pearce, who has been with the company since 2010, has a challenging role given Forrest’s ambitions and the speed of Fortescue’s project implementation and growth. This growth requires significant investment of capital while managing a substantial debt burden.⁷

Infrastructure and operations

Fortescue has developed two areas of operation in the Pilbara region: the Chichester Hub and the Solomon Hub. The Chichester Hub comprises the Cloudbreak and Christmas Creek mines. A 256 kilometre rail line links Cloudbreak to the Fortescue Herb Elliot Port. In 2010, this rail line was extended 40 kilometres west to Christmas Creek. Cloudbreak’s train loading facility can load 16 000 tonnes of iron ore per hour on Fortescue’s trains, which can be up to 240 freight cars and 2.7 kilometres in length. Cloudbreak and Christmas Creek currently produce 55 million tonnes of iron ore per annum and this is expected to increase to 95 million tonnes. At Cloudbreak, deposits are horizontal, so they require a different approach to mining than those sites whose deposits are vertically oriented. This approach necessitates overburden removal through the use of conventional blast, shovel and truck techniques. The iron ore is then cut and loaded by specially-designed surface miners into the trucks for transport. The product is then screened, crushed and refined at the Cloudbreak facility prior to transport to the port.⁸

The Solomon Hub is located in the middle of Fortescue’s 88

000 km² tenement area, 120 kilometres west of the Chichester Hub.⁹ Exploration has located three billion tonnes of iron ore at the site. Construction of the mine started in 2011; however, development was delayed in 2012 after iron ore prices slumped.

The industry

Mining and mining services are two of the industries in which

Australia has national competitive advantage. Mining giants BHP Billiton Ltd (BHP) and Rio Tinto Ltd (Rio Tinto) have dual stock exchange listing arrangements with the ASX and the London Stock Exchange, and both run extensive operations in

Western Australia’s Pilbara region. Hancock Prospecting Pty Ltd, controlled by Australia’s richest woman Gina Rinehart, also has extensive operations in the Pilbara region. Iron ore mining in the Pilbara region is capital intensive, requires strong project management skills, access to substantial financial resources, and long lead times for project completions. Distances are vast, and accessing a skilled workforce, housing that workforce, and providing community facilities in remote locations is a challenge.¹¹ The tremendous demand for iron ore and coal from China in the last decade, as well as favourable commodity prices, has assisted contract negotiations for iron ore for the large Australian mining companies. There are well over 2000 companies listed on the ASX and the materials sector is strongly represented in each of the small, medium size, and big company sectors. The success of a start-up such as Fortescue evidences the capacity for new entrants to gain traction in this industry.

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Sources of competitive advantage

Forrest is both very experienced and well networked in the financial and political community — especially in his home state of Western Australia. He has been adept at building positive working relationships with state and federal politicians and his background experience as a skilled project financier and manager on the mining scene has been of value in informing his practice in the Fortescue start-up.

Exploration has been a high priority for Forrest and his team from the earliest days in 2003. Fortescue has been recognised as the company with the highest financial commitment to exploration in Australia. Many of the original exploration team members are present and active today across the Fortescue operations, helping to identify a now substantial 11.4 billion tonnes of reserves of iron ore across only 20 per cent of its 88 000 km² Pilbara tenement.¹² The exploration team’s aim is to add

1 billion tonnes per annum to the resource portfolio of

Fortescue, to provide the company with a sustainable competitive advantage. Fortescue has positioned itself as a lowcost producer with a culture that promotes workplace safety and teamwork.¹³

Fortescue is also well known for its contribution to the wellbeing of a range of stakeholders beyond their shareholders, and this is evident in the way the company has been developing and operating in the Pilbara since 2005. There has been substantial investment in local communities through Fortescue’s housing construction, residential workforce and vocational training and employment program.¹⁴ Fortescue’s goal of training and employing 300 Aboriginal people was achieved by 30 June 2011. Fortescue is publicly committed to the Australian Employment Covenant which is a countrywide initiative to create 50 000 jobs for the Aboriginal people.¹⁵ Fortescue has also been working with its mining services project partner WorleyParsons on minimising the environmental impact of the dredging program at Port Hedland.¹⁶

Human resource management

Growth in the activities of major resource players such as BHP, Rio Tinto and Fortescue has led to cost pressure for labour and equipment in the West Australian mining sector. Labour costs are high in Australia and the workforce is known for its lack of mobility. Prior to the 2012 delay in its expansion plans, Fortescue required 200 new employees per month and actively sought extra workers from the eastern states of Australia. At Cloudbreak, 2000 workers are scheduled eight days on and six days off. It is argued that this schedule is more conducive to family life. There is a 1600-bed operations village at Christmas Creek to provide permanent housing for the workforce.¹⁷ Shortterm accommodation is available at Fortescue’s 700-room Hamilton Hotel in Port Hedland which is being expanded by a further 272 rooms. More than 300 Fortescue families live in Port Hedland and a Pilbara Residential Home Ownership scheme has been developed to encourage Fortescue workers to settle in the Port Hedland region and make a contribution to community life.

Corporate governance evolution

Fortescue started business in April 2003. Forrest as founder and key strategist has had a substantial influence on the success of Fortescue so far. Initially, Forrest was non-executive chairman; however, this changed when he was appointed CEO in 2005. Duality of the chairperson and chief executive officer role is nowhere near as prevalent on ASX-listed companies compared to New York Stock Exchange listed companies. Australian and British corporate culture prefers separation of these important roles. Forrest resumed as chairman in a non-executive capacity in August 2011. Present-day deputy chairman Herb Elliott has also played a prominent role at Fortescue, having been an independent director

(Grant 433-435)

Grant, Robert, Bella Butler, Stuart Orr, Peter Murray. Contemporary Strategic Management: An Australasian Perspective, 2nd Edition. John Wiley & Sons Australia,, 08/2013. VitalBook file.

Question 1

What are the nature and sources of Fortescue’s competitive advantage?

Question 2

How has the setting of goals and values assisted Fortescue in achieving strong organisational performance?