The Arrogance of Inco – by Val Ross (Originally Published in May 1979 – Part 3 of 4)

“The Arrogance of Inco” was originally published as the cover story in the May, 1979 issue of Canadian Business. Reporter Val Ross, who died in 2008, spent two and a half months researching and writing this lengthy expose of the then Inco Limited. It has become a “classic must read” for anyone wishing to understand the often bitter history between Sudbury and the company that defined the Canadian mining industry.

3-Foreign Wars, Foreign Conquests

World War One boosted International Nickel up fortune’s wheel. The demands of World War Two and the Cold War arms race would put the company over the top – and heading down.

In the second half of the century Inco reaped the consequences of what it had sowed in the first the demand it had created for nickel ultimately exceeded its capacity to produce it – and left a vacuum for new producers to fill. Its booming good health attracted envy from customers, who might, had Inco been less arrogant, have felt more loyalty to the company when the chips were down; and it also attracted the critical attention of governments, consumer groups and environmentalists.

No one foresaw this, of course. The company’s chairman and president during World War Two, Robert Crooks Stanley, the man who’d spent four decades of his life convincing the world of nickel’s place in civilian life, made the necessary adjustments to war in a spirit of confident responsibility. “The first obligation of every corporation,” he noted serenely, “is to give the utmost support to his [sic] government in the prosecution of the war.” He plowed $38.5 million of the company’s money into boosting production by 20% and expanding the Huntington rolling mill facilities. Just as in World War One, the company nearly doubled its nickel output. But to do so it sacrificed costs, efficiency and profits, which dropped from $37 million in 1939 to $25 million in 1945.

Meanwhile, Stanley’s friend and fellow board member, John Foster Dulles, was creating a niche for himself in the postwar world. Dulles chaired the corporate heavyweight Committee for a Just and Durable Peace sponsored by the National Council of Churches of Christ in America; advised the American delegation at the United Nations conference, and made more and more friends with the Republican party establishment. It must have seemed to the board of directors that the company’s postwar position would surely be enhanced by friends with such political power.

They were wrong. America’s leaders were busy wrestling with the problem of containing communism and establishing postwar global stability. Reasoning that stepped-up trade with underdeveloped countries would deter them form going communist, the American policymakers resolved to diversify US foreign trade. Put simply, both policies led to the encouragement of international competition and the breaking up of monopolies.

Notwithstanding Stanley’s responsible wartime PR, in 1946 the US Justice Department filed suit against Inco’s American subsidiaries, charging monopolistic practices. The company won the suit two years later, but it had to promise that it would supply nickel to all alloy mills, including its own, at uniform prices.

As the Cold War continued, Inco’s position was further undermined. The Korean War had caught the company short of supplies; the cause of the Free World, vowed the US government, must not be left in the hands of fallible corporate prophets. Accordingly, the Defence Department classified nickel as “the world’s most critical material” and began stockpiling it – $789 million worth between 1950 and 1957. Inco’s monopoly control of supply was over.

The Defence Department also groomed Inco’s competition. In 1948, it awarded tiny Falconbridge (born in 1928, and now nearly broken by wartime interruption of its Norwegian refiner operations) a contract for 40 million pounds of nickel. Falconbridge got another contract in 1951 for 50 million pounds, with $6 million in advance; than in 1953 the Defence Department ordered 100 million pounds at 40 cents above the prevailing price. Since the prevailing price was Inco’s, it amounted to a $40-million subsidy to the company’s competitor.

Inco’s mistake, ironically, had been in demonstrating that it was a crucial part of US defence policy – too crucial. Soon it became clear that its product was to crucial a part of civilian life as well. The capital spending boom of the 1950s caught it as unprepared as the Korean War had done, and the shortage of nickel for car bumpers, can openers, stainless steel washing machines and stainless steel tableware – the whole glittering consumer glut – was exacerbated by the US government’s stockpiling policy. The company, as a visible source of nickel, took the rap. As Fortune commented, “The chronic and intense character of the nickel shortage suggests that Inco, despite its growth, has been overly cautious….Says a Canadian competitor, “They did such a good job of building the market, they never noticed when it went right by them.” Inco had created a hunger it couldn’t appease.

As news of Falconbridge’s sweetheart contracts with the US government cast a deep shadow over Inco’s executive offices, more competitors crowded like tiny clouds on the horizon. Sherritt Gordon Mines Limited had started producing nickel and copper at Lynn Lake, Manitoba, in 1953. By 1955 it was producing 17 million pounds; not a lot compared with Inco’s annual 285 million pounds, but Sherritt Gordon wasn’t alone. Nickel was also starting to arrive from the tropics, including Cuba.

What was interesting about Cuba’s nickel was the kind it was. It wasn’t from rock rich with copper, platinum and gold, like Sudbury’s hard sulphide ores, or from rich nickel silicate veins like New Caledonia’s. Cuba’s ore was lateritic, in the form of clayey oxide deposits that lay just under the surface of subtropical forests. In the early 1950s, processes for extracting the nickel from these generally low-grade ores were perfected. Prospectors, sensing wealth, sought and fund lateritic nickel in Cuba’s neighbour, in Nicaragua, Guatemala and the Dominican Republic. There was more in Southeast Asia. Then another competitive factor came into play: the Southeast Asian producers, the Rothschilds’ Le Nickel foremost among them, were best placed to take advantage of the fast-growing Japanese steel market.

For itself, the nickel giant Inco wasn’t looking east or south with much conviction. Doc Thompson, president and later chairman of the board, scarcely mentioned overseas exploration for laterites in his 1960 book, For The Years To Come. Nickel was Inco was Sudbury. Yet nickel consumption after 1946 was rising at least 6% a year, and the company just couldn’t keep up. Observers and insiders alike agreed that the only course was to expand production.

Perhaps because of its familiarity with sulphide ores, the company focused most of its exploration energies on the Canadian Shield. The 10-year search cost $31 million, some of which went to a group of young Toronto scientists to perfect airborne electromagnetic detection systems. With this pioneer equipment, company men were able to scan hundreds of thousands of miles of subarctic wasteland.

Northern Manitoba was one promising area; Sherritt Gordon’s copper and nickel mines were there. In February, 1956, president Henry Wingate got a call from Manitoba. The report: “It looks like we’ve hit the jackpot!”

Four hundred miles north of Winnipeg, and just far enough south of the tree line for there to be tenacious little birch and grim little spruce, at a place in the middle of nowhere called Moak Lake, the company made its stand. Moak Lake’s – Thompson’s – ore reserves were originally estimated at 25 million tons.

The first house was built in Thompson in 1958. By Christmas 1959 the community had grown to include its own hotel, to which everyone repaired for a 24-hour New Year’s party that Thompson people still recall with dismay.

For, although the community was carefully planned by Manitoba’s Department of Municipal Affairs as a model new town with shopping areas, hockey rinks, marinas and other mod cons, no matter; booze and brawls inevitably became the residents’ answer to the isolation of the place. Labour turnover at Thompson has at times reached 120%.

The company had other problems with Thompson. Though the US government was accelerating its stockpile program, Inco’s men in Washington couldn’t get the Americans to buy Manitoban nickel. The Americans kept directing their best contacts to Cuba. So the fledgling nickel town would have no protection in times of surplus, or whenever cyclical demand for nickel turned down. (Though Cuba ceased to be a source of American nickel after its revolution, the US policy of fostering alternate sources to Inco’s nickel has stayed in place.)

Yet somehow, Thompson expanded. The addition of its refining facility increased the company’s nickel output by a third. But the insatiable international market was still not appeased. After having spent $400 million developing Thompson, in the late 1960s Inco plowed $1.1 billion into expanding production even further.

And still it couldn’t keep up with the demand for nickel.

By this time, the Vietnam War was gobbling the metal. Other producers moved into the supply vacuum left by Inco, offering low-grade nickel with the iron impurities left in. This material was called ferro-nickel. It was cheap, it added its own rough iron content to the steel mix, and above all, it was readily available.

Why was Inco so slow to pick up on the ferro-nickel market? A Toronto metals analyst suggests, “I think the problem was psychological. Inco was nickel, the pure stuff. So they didn’t react to the changing needs of their customers for a cruder product.”

The truth was, the company’s leaders were getting old. Doc Thompson, who’d started the company’s research labs in 1906, was still around as honorary chairman. There were other men on the board in their nineties. Chairman Henry Wingate’s background was law not sales or metallurgy. Even if the company’s declining market share did startle these cautious, senior nickel men out of their golden years reveries, they seemed incapable of moving the company fast enough into new markets, new products and new competitive battles.

By the 1960s it was thought 80% of the world’s nickel reserves were in the tropics in the laterite ores. (Estimates of seabed reserves have now outstripped laterites as the world’s largest nickel reserves.) There would be no more Sudburys, no more Thompsons. The company would have to expand overseas. This time, its political connections made its way easier.

In 1953 US President Dwight D. Eisenhower made John Foster Dulles his Secretary of State. In 1954 John, together with his brother, CIA head Allen Dulles, helped the United Fruit Company topple a left-leaning democracy in Guatemala. By 1956 the new Guatemalan government had opened its arms to free enterprise, among others the Hanna Mining Company of Cleveland, Ohio. Hanna found nickel in Guatemala. Unable to develop the ore on its own, in 1960 it turned 80% control of the proposed project to Inco. Together they incorporated a new company, Exmibal. But development of the Exmibal holdings was held up for political reasons – chiefly for discussion of the troublesome 53% local mining tax. Whenever it looked as if the government was about to grant Exmibal a 10-year tax holiday, patriotic protests halted the move. In Central American politics, “patriotic protest” means more than letters to the editor. In the course of suppressing sometimes violent criticism of the government, at least two lawyers who were prominent critics of the Exmibal project were gunned down – plus the usual quota of students.

The Guatemalan government didn’t confirm agreement for the $250-million project until 1971. At the time it was expected to produce 60 million pounds of nickel a year. At time of writing, technical bugs such a faulty kiln lifters in the project are still being ironed out. The estimate of capacity is down to 28 million pounds annually, but costs are still projected at $224 million.

Indonesia, another of the many countries that John Foster Dulles tried to “stabilize,” was also rich with lateritic ores. In 1968 Inco acquired exploration and development rights to a 25,000-square mile tract of land. The company hired Robert de Gavre, a boyish-looking Princeton graduate with a mid-Atlantic accent, away from Exxon Corporation to organize the financing of both the Indonesian and Guatemalan projects. The job required all of de Gavre’s attention and ingenuity. No investment bank could have had enough commitment to the problems these projects faced, nor could any have come up with de Gavre’s intricate solutions. One problem was the reluctance of investors to back an unpredictable Latin American project. Allende’s Chile had nationalized its copper mines the year before the Guatemalan deal was concluded; and the Guatemalan government had just declared martial law. Jetting frenetically round the world, de Gavre was forced to court a wider than usual number of money sources. “Guatemala wasn’t as clean a structure as the Indonesian project,” remarks the company’s financial whiz; de Gavre is, of course, referring to aesthetics and not ethics.

In Indonesia his principal challenge was to involve the Japanese steel industry giants, so that they would have a stake in buying the nickel the project produced. Another problem was the oil crisis. Not only did oil shortages mean a paralytic squeeze in world capital spending, which would constrict the Japanese steelmakers; they also meant rocketing costs for most projects involving lateritic nickel, which tends to require more energy for smelting and refining than do the Sudbury-type ores. In response to the oil crisis, Inco thought it would be a good idea to invest in a hydroelectric dam in Indonesia. But with the additional investment, a much larger mining project was required to justify the extra cost. The Japanese, who had invested in the first stage of the project, politely declined the opportunity to invest again. Consequently, Inco’s equity participation in the Indonesian project increased from 75% to 96%.

Inco had decided on project financing for both its overseas ventures to keep the risk off its own balance sheets and to spread it around. In both cased the financing would be one part equity ($45 million, mostly Inco’s in Indonesia; $30 million, form Inco and Hanna, in Guatemala) to two parts debt. Since the size of these debts was horrendous, the company borrowed all over the place – “in bits and pieces,” as de Gavre puts it. It obtained loans from the Export-Import Bank and Citibank in the US, and from Bank of Montreal and the federal government’s Export Development Corporation in Canada. The EDC’s participation in Inco’s projects eventually totalled $70 million in loans – loans that would come back to haunt the company’s Canadian operations.

De Gavre executed these projects with laudable success. But the projects themselves have backed Inco into a corner. Whereas previously Inco wanted to sell nickel to maintain its historic position, now it has to sell nickel to meet its debts. “The problem,” says de Gavre – now Inco’s treasurer – with classic British understatement, “is financing your debts when nickel prices are low.” That financing amounts to repayments of about $90 million a year; $900 million of the total $1.2-billion debt must be paid off within a decade.
“Inco’s made two mistakes,” says metals analyst Patrick Mars. “They went heavily into debt over two tropical laterite projects at the same time-inevitably a bad move, like Hitler fighting on two fronts. And for some reason, they’ve continued to underestimate the market for low-grade nickel.”

In 1971-72 Inco made another major misjudgement: the market. Nineteen seventy-one, said its market experts, would be bullish. Accordingly, the company stepped up production. Instead, as de Gavre puts it, “the nickel market fell out of bed.” Demand for the company’s products plunged. Its shipments fell 34% and its profits dropped 55%. That same year, Falconbridge actually increased its market share from 9% to 14% – because it was selling ferro-nickel.

Inco’s sky darkened as other chickens came home to roost. With a confidence inherited from its monopoly days, the company had become particularly absent-minded about getting contracts. Falconbridge’s other advantage in 1971-72 was its long-term agreements to supply its customers with nickel, whether the markets softened or not. Inco, whose selling methods were generally lax, had no such contracts.

Inco lawyers question whether Inco, still giant in the nickel field, could have gotten contracts from its customers, since by excluding other customer companies, such contracts might have been construed as preferential. In any case, Inco failed to protect itself. It had become the supplier of last resort. When the nickel market went sour, in 1971, its competitors suffered far less than Inco. And so Inco became burdened with the cost of maintaining unsalable inventories just as the debt repayments of all those 1960s expansion programs peaked.

By 1974, the demand for nickel had picked up again. In fact, by the end of the year Inco was again placing its clients on allocation. A new chairman, Ed Grubb, brought in in 1972, had been trimming costs, particularly payroll; by 1974, 6,000 contract and staff workers were dropped. That year the company’s profits approached $300 million. Feeling good enough to make it first major move into diversification (to offset the cyclicality of nickel), Inco bid $234 million for ESB Incorporated, the world’s largest independent battery maker. In other diversification moves, it acquired Daniel Doncaster & Sons Limited, a British-based high-stress aircraft engine manufacturer, and Diado Special Alloys Limited, a joint venture in Japan.

As the world’s largest nickel supplier, the company continued its policy of posting the official price of nickel, in spite of competitors undercutting, and it continued to stockpile. Still viewing itself as the responsible guardian of stability in the industry, it believed its new policy of getting contracts and its diversification moves would protect it from further shocks.
It was wrong. In 1975-76 it made the same bullish predictions about nickel markets as it had in 1971 – with the same results. Inco’s brief to the Ontario Legislature’s Select Committee on the Layoffs explained, “in 1976, based on previous cycles and on economic projections, we anticipated some market recovery. What emerged was a more modest recovery than originally projected….We entered 1977 anticipating the accelerated recovery of previous cycles.” But it didn’t happen. The company was partly misled by a modest upturn in demand for nickel, which was in fact due to customer stockpiling. As customers inventories but up, so did those of the nickel producer. Yet amazingly, though prospects of an improvement in world capital spending had dimmed by 1977, production continued unabated at Inco. A month before the layoffs, the men were still putting in overtime at the Sudbury mines.

On top of the layoffs, Inco’s debt crunch compelled it to knock its quarterly dividends from 35 cents to 20 cents, and to omit the year-end dividend entirely.
And meanwhile, as Inco twisted and turned in response to its cyclical fortunes, it began to attract the public attention it had learned to fear. David Levis, the leader of the federal New Democratic Party, got wind of the news that the government had deferred the company’s taxes during the expansion years. He came up with the phrase “corporate welfare bum” in time for the 1972 federal election and pinned it squarely on Inco.

(By 1973, the company’s deferred taxes totalled $273 million.) When the company announced layoffs in Sudbury and Thompson, Canadians demanded to know why the Export Development Corporation had lent it $70 million to export jobs overseas. The questions that had never been asked in the company’s good times flooded to the fore as it headed down on fortune’s wheel. Profits fell again in 1976 and 1977. And people started asking: What about Inco’s safety record? What about its labour relations, which Fortune magazine, no less, had dubbed “appalling”? And what about pollution?

For part 4, click here: http://www.republicofmining.com/2010/06/30/the-arrogance-of-inco-by-val-ross-originally-published-in-may-1979-part-4-of-4/

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