More on BHP, Rio Tinto and China

While most people were focused on the Super Tuesday election results in the U.S., overseas the fate of Rio Tinto, which I’ve written about here recently, saw some developments.

First, BHP Billiton Wednesday raised its bid for Rio Tinto to US$147.5 billion, in a proposed share swap. This comes after China’s Chinalco and U.S.-based Alcoa teamed up to buy 12 percent of the company for about $14 billion.

Last week, BHP signed an iron ore supply deal with China’s Baosteel, providing further perspective on the global steel and iron ore industries and how China fits into the mix.

Here are the key points, but perhaps the most important is #3:

1. BHP Billiton Ltd., the world’s largest mining company, will supply an extra 94 million metric tons of iron ore to China’s Baosteel under a 10-year contract, with prices to be agreed each year.

2. Imports of iron ore by China, the world’s fastest-growing major economy, are forecast to double in the next six years.

3.” Baosteel and other Chinese steelmakers have to buy more iron ore from the major miners because they couldn’t find sufficient supply elsewhere for the moment,” said Helen Wang, a Shanghai-based analyst at DBS Vickers Hong Kong Ltd. “The fast expansion of China’s steel industry needs more iron ore.”

4. China has accounted for 65 percent of global growth in steel production in the past 10 years, and is now four times the size of the U.S. steel industry.

5. Baosteel, China’s biggest steelmaker, plans to boost production capacity to 80 million tons a year by 2012 from an estimated 28 million tons last year, closing the production gap on the top global mill, ArcelorMittal. The company would require 120 million tons of iron ore to meet the production target, according to Ma Haitian, an analyst with Beijing Antaike Information Development Co. Baosteel used 42 million tons of ore in 2006.

6. BHP, Rio Tinto and Cia. Vale do Rio Doce (“CVRD”) account for three-quarters of global iron ore exports.

7. Steelmakers may be short as much as 25 million metric tons of iron ore this year, similar to 2007, Credit Suisse Group said on January 16. The shortage may help iron ore producers win a 70 percent price increase in contract prices starting April 1, the brokerage said.

8. The steelmakers have a “sharp discrepancy” with the miners on agreeing prices, China Iron and Steel Association Vice Chairman Luo Bingsheng said. Contract prices have tripled over the past five years.

Add it all up and the conclusion is the same: for the sake of China’s steel industry and the country’s economy, Chinalco and Alcoa better succeed in keeping Rio Tinto as an independent company. The gap between supply and demand of iron ore seems to be getting bigger, not smaller, and even with three independent iron ore suppliers, price negotiations are contentious for the Chinese. Imagine what they will be like if there is a duopoly.

Apart from price, assurance of iron ore supply could be a real concern if Baosteel intends to match Arcelor Mittal’s production capacity. Since the supply chain from Australia, where BHP and Rio Tinto have most of their production, is considerably shorter than it is from Brazil where CVRD is located, China really only has two cost-effective suppliers: BHP and Rio Tinto. A combination of BHP and Rio Tinto would reduce that to one, making price and assurance of supply of a key raw material for one of China’s most basic industries a true Achilles heel for the Chinese economy.

For that reason, I was a bit disappointed when I read that Chinalco’s President Xiao Yaqing told journalists in Sydney Monday that the group’s investment in Rio Tinto was “strategic” and it had no plans to increase its stake. That statement seemed to be a step back from what the company said Friday when it took its ownership stake in Rio Tinto.

BHP, which had until the close of business Wednesday London time to formalize its bid for Rio Tinto under UK law, announced an offer of 3.4 of its shares for every Rio Tinto share. This offer represents a 45 percent premium to the Rio Tinto share price prior to BHP’s approach.

In light of BHP’s improved offer, which the BHP CEO has described as “compelling” for Rio Tinto shareholders, Chinalco and China will have to decide fairly quickly how they will play this latest development.

Welcome to global M&A, 21st century style!

No comments yet... Be the first to leave a reply!