Rio Tinto: Time For A Package Deal

Rio TintoWhat a difference six months make. Can you believe it was only six months ago that Rio Tinto shattered steel stock prices across Asia when it announced that Baosteel, China’s biggest steel group, agreed to pay up to 97 percent more for its iron ore?

And even that wasn’t enough for BHP Billiton, the other big Australian mining company that together with Rio Tinto and Brazil’s Companhia Vale do Rio Doce control 79 percent of the world’s iron ore supply. BHP said that the price negotiated by Rio Tinto was not enough and began moving ahead with a plan to end the annual contract system favored by its Australian rival. Instead, BHP wanted a hybrid system–between the spot market and the traditional annual contracts–with automatic price revisions depending on the tightness of the market.

Ironically, with demand for steel and iron ore dramatically lower, China’s steel companies now want to move towards just such a system. China, the world’s largest iron ore consumer, announced Monday that it may ask Rio Tinto Group and its rivals to accept an 82 percent price cut for the raw material.  Since steel prices have fallen to 1994 levels, China’s steelmakers believe that iron ore prices should follow suit. Moreover, the Chinese steelmakers want the new annual pricing to start from January 1, 2009, instead of from April, and want the prices to be set more frequently rather than on an annual basis–similar to what BHP was proposing in June.

This comes at a bad time for all three miners, but particularly for Rio Tinto as it struggles under a very heavy debt load. China’s demands are even more severe than the 50 percent price cut that Australia and New Zealand Banking Group Ltd. has forecast for the iron ore producers.

Perhaps it’s time for a package deal between China and Rio Tinto? Chinalco, which already owns 9 percent of Rio Tinto, gets more shares in exchange for cash support and its help in negotiations with China’s steelmakers. Could this be what China had in mind when it proposed the drastic price cuts? This may end up being a very interesting three-way negotiation, with China ending up in greater control of a key natural resource. 

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