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Rio Tinto (NYSE:RIO) Ventures (Mauritius), a subsidiary of Anglo-Australian group Rio Tinto, has set up a partnership for coal prospecting in the Tete province with the Mozambican state mining company Empresa Moçambicana de Exploraçao Mineira (EMEM). EMEM focuses on geological mining, advisory, consulting and technical assistance, carrying out prospecting and research for natural resources and development of partnerships with other national and foreign companies.

The new company will be called Minas de Changara, in which Rio Tinto will own a 75% stake while EMEM will own the rest. The joint venture company will begin operating with three coal prospecting and research licenses that are already owned by Rio Tinto via Rio Tinto Changara.

The significance of the partnership arises from EMEM being a state-owned company. Rio Tinto has been facing problems with transporting its coal from pit to port because of inadequate transport infrastructure. We think that this partnership might get Rio Tinto two things: Some funding and more attention from the Mozambican government as far as transportation is concerned.

Problems in Rio's Mozambican Coal Business

Rio Tinto took a $3 billion impairment charge in the fourth quarter against its Mozambican coal business. This business was acquired as recently as 2011, when Rio acquired Riversdale for $4.2 billion. The writedown of $3 billion thus wiped out nearly 75% of the value of the acquisition. The primary drivers for the impairment were the lack of adequate transportation capacity, a downward revision of the quantity, and quality of reserves at the mines and the rapid fall in coal prices.

To successfully carry out mining activity, supporting infrastructure is needed to transport the produce from the mine to the port. Mozambique has a severe deficit of transport infrastructure, the need for which wasn't felt before the mining industry took off. Rio's mines are located in the Tete province, and coal from here needs to be transported over 600 km to Beira. From here, the coal is loaded on small vessels and sent offshore where it is reloaded to a loading terminal. The entire journey costs a lot.

Rio initially planned to transport coal by barge along the Zambezi river, but the government shot down the proposal on environmental grounds. While both the government and private companies like Vale are planning to build transportation infrastructure, it will take at least five years before the results are visible on the ground. Not just that, the government's share of costs alone are estimated to be $12 billion, which is equivalent to Mozambique’s entire GDP.

The New Partnership

Rio Tinto will fund prospecting and research work, and the two partners will be responsible for financing the project's development if the prospecting work shows it is feasible for it to be developed. So while Rio will bear the initial cost, EMEM will share a part of the financial burden if development eventually happens. This may suit Rio considering that the company is going to cut down on capital expenditure and operating costs in the next two to three years. According to the company, the 2012 capital expenditure of $17 billion represents the peak.

We also think that partnering with a state company will help Rio gain more leverage with the Mozambican government in getting the mined coal to the port. The government might be more amenable to permitting at least limited barging of coal along the Zambezi river since the interests of a state-owned company would also be at stake if the joint venture discovers feasible deposits in the same area. This would remove operational bottlenecks to some extent.

We have a Trefis price estimate for Rio of $56.

Disclosure: No positions.

Source: Will Rio Tinto's New Partnership Solve Its Mozambican Coal Business Woes?