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Inco follows the money east

From Saturday's Globe and Mail

The history and future of Inco Ltd. C collide on a windswept field by the Yellow Sea, on the northeast edge of China.

Inco's history rolls in on big container trucks carrying orange-and-white bags of nickel pellets, mined and processed in Sudbury, the 102-year-old company's traditional production base.

The future is what happens inside Inco's sprawling new factory in Dalian, a port city of six million. In the spare, immaculate plant, those pellets end up in big electroplating vats, where the metal is melded with polyurethane foam to form nickel foam, a critical element in today's rechargeable batteries.

Inco is using Chinese labour and technology to feed a surging new market, and to form a global supply loop that, for Canadians, is both innovative and sadly familiar: Nickel mined in Canada is undergoing value-added transformation in China, only to return to Canada, eventually, inside the batteries of energy-efficient Japanese hybrid cars, such as the Toyota Prius.

It's becoming a common theme in business: Entire supply chains are picking up and moving to China, and not just in labour-intensive industries like apparel and toy making, but in technologically advanced sectors like autos and electronics.

For Inco, the Dalian venture also speaks to its evolution into something more than just an efficient miner. Sure, it continues to seek out low-cost nickel deposits, whether at home in Canada — the oncoming Voisey's Bay project in Labrador, for example — in the South Pacific, or, it hopes, in China.

But it also regards itself as a global marketer, plugged into major customers, and nimble enough to move downstream to capture value. The world's No. 2 nickel supplier feeds more than 10 per cent of its tonnage into production of specialty materials, such as nickel battery components and other auto parts. That's a much smaller but more profitable business than digging the stuff out of the ground.

"You don't be the leader by being all about ore bodies and low cost — you do it by finding new products," says Scott Hand, the company's chairman and chief executive officer. "You don't stay competitive by just selling nickel on the LME [London Metal Exchange]."

And for companies like Inco, you don't stay competitive without going to China.

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Inco says it has to locate in China because its customers and competitors are there, or they're a short hop across the sea in Japan.

"You have to do [the manufacturing] where the market is," says Peter Goudie, executive vice-president for marketing and the driving force behind the 10-year thrust into China. "The battery market is in Asia, and increasingly in China.

"A large part of it is about presence. You want to be identified as a local supplier to local companies."

Mr. Goudie insists labour costs are a secondary factor, although they are a crucial part of the Chinese value equation. Total compensation for an operator in the Dalian plant is $200 (U.S.) a month, roughly what the average Sudbury worker makes in 10 hours.

More important is the size and promise of the Chinese market. More than 10 per cent of Inco's $4-billion in annual sales now comes from China, which is about to pass Japan as the world's largest nickel consumer.

Two-thirds of the world's nickel goes into making stainless steel, and China accounts for 20 per cent of global stainless steel demand, more than Japan and the United States combined. Soaring steel production is one of the fundamental underpinnings of China's growth strategy, and its appetite helped push the nickel price to a 15-year high early this year, although it's retreated recently as China has tried to moderate its heated economy.

As China seeks to secure supplies of such vital materials, the global mining industry is caught up in powerful crosscurrents. Inco is pushing harder into China as an explorer and processor, while Chinese firms are moving in the other direction. Control of Inco's Canadian rival Falconbridge Ltd. C seems likely to end up with China Minmetals Corp., C a state-owned company fulfilling Beijing's mandate to nail down strategic supplies.

Meanwhile, in the downstream battery material business, competition comes not from alter ego Falconbridge, but from Asian industrial giants and Chinese players with names that, until recently, most people in Inco's Bay Street offices hadn't even heard of — companies such as Lyrun, from the inland province of Hunan.

Not that Inco is a rookie in this Chinese hothouse. The Dalian venture is just the latest in a network of interests stitched together by Mr. Goudie, a 30-year company veteran whose father and grandfather were both underground miners in Broken Hill, Australia.

For a decade, Inco has operated a sales office in Shanghai; for the past seven years, it has been producing nickel salts for the plating industry in a nearby factory. It is now lending its ore-finding expertise to a joint venture with Jike Mining Co., a state-controlled firm looking for nickel in China — part of the explosion of mining exploration in China and neighbouring Mongolia.

Dalian is also a leading candidate to become the site of a new Inco plant that would process output from its massive Goro mine in New Caledonia, which Inco indicated this week should begin production in September, 2007, after a delay from cost overruns.

China, in other words, will become a major theatre of operations for Inco. Although still a Canadian company, its executives would like nothing better than to have a large integrated exploration-to-refinery operation in China.

"In the long term you always want to look for a complete approach," Mr. Hand says. "We have to find new ore bodies, and wouldn't it be great to find one in what next year will be the world's biggest nickel market?"

Inco also wants to participate in future consolidation of the Chinese battery materials industry. Last weekend, Mr. Goudie signed an agreement to buy the assets and business of a Chinese nickel foam producer in Shenyang, just north of Dalian. Such acquisitions would help secure its market leadership in high-end nickel batteries and fuel cells, used in everything from cellphones to scooters and cars.

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The major producers are shifting to China, and it was the search for a nickel-foam presence here that led Mr. Goudie to Dalian, an ice-free port in the northeast region once known as Manchuria, an area rich with reminders of former occupation by Russian and Japanese forces.

The factory setting is itself another striking collision of history and future. On a nearby highway, a man strains to pull a cart filled with his possessions up a steep hill, as BMWs and Buick minivans whiz by. Alongside the factory sprawls a crude collection of tin and wood shacks, temporary housing for the workers on the construction site.

Yet the plant's interior is a monument to the latest production technology. Several PhDs are on staff, testimony to Dalian's status as an educational centre.

Inco's venture here defies the stereotype of China as a low-cost, manufacturing ghetto. At a meeting at Dalian city offices, Mr. Goudie takes pains to assure the local mayor, Xia Deren, that the company is performing its lower-value extraction and processing in Canada while the local plant undertakes higher-value-added work. The mayor smiles contentedly — it's the kind of thing that municipal officials love to hear, whether in Northern Ontario or Northern China.

By the end of the year, the nickel foam plant will employ 250 people, roughly 80 per cent of Inco's China work force. Dalian will not mean the loss of Canadian jobs, but it will clearly benefit from future expansion. The complex contains three production lines and capacity for a fourth to be brought on line quickly. Inco, which has already invested $17-million on the venture, owns enough land to triple the size of the operation.

Management says it still has strong commitment to value-added work in Canada, and it has been hiring in Sudbury. "It's not a case of a loss of Canadian jobs but it's about being realistic and being in the markets you want to be in," Mr. Goudie says.

In Dalian, Inco has teamed up with a property developer who owns 3.5 per cent of the joint venture and has contributed locally developed technology. Inco owns the remainder, both directly or through a South Korean joint venture. Mr. Goudie says the Dalian venture should make money in its first year on $35-million in sales.

But it is not all smooth sailing. Mike O'Sullivan, project manager in the Dalian plant, says the paperwork required to serve the myriad layers of Chinese bureaucracy is 20 times greater than in Canada.

Instilling a culture of worker safety has been another huge challenge. Many of the construction workers, he says, had never tried on steel-toed boots or hard hats. They thought nothing of scrambling up a rickety ladder. The toughest thing is to get workers to see safety as a team responsibility, he says, and to look out for the mistakes of colleagues.

But the greatest danger to Dalian comes less from on-the-job perils than from rivals or even partners. One Canadian businessman with long experience in China says the key question is: What is so special about the plant's processes that Chinese producers can't perform them on their own?

The risk, he says, is that Chinese producers will study the operations and nickel battery formulations, and simply duplicate them. The banks provide easy credit for local companies, allowing them to overproduce and flood the market with low-cost substitutes. In China, the aim is not always to make money but to mercilessly drive down unit prices, the businessman says. Inco could wake up one morning to see its returns wiped out.

Inco managers don't dispute that they have to monitor the Chinese producers, and there are always fears that they will be undercut. The theft of intellectual property frightens every Western company that ventures into China, in whatever sector.

But the more Inco learns about China, the less risk it takes on in tackling anything big in the country. To launch the Dalian plant, the company pulled in members of its management team in Shanghai. It brought Mr. O'Sullivan, an experienced project manager, from its Indonesian operations, where he had spent six years.

"For anyone who hadn't worked in the Third World before, this would be a very difficult place to do business," Mr. O'Sullivan says.

But Inco can boast a corps of managers who have earned their stripes all over the world, in New Caledonia, Indonesia, Labrador and Shanghai. Many are now learning the ropes in Dalian and will be battle-ready when the next project calls, or the next hot market.

"We are nickel and we're proud of it," says Scott Hand. "We want to be the leading nickel company in all aspects, and so we have to go where the markets are."

And at this moment, that is clearly China.

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