Chinalco Discusses Raising Its Stake In Rio Tinto

Not surprisingly, Chinalco and Rio Tinto are in discussions regarding the former taking a larger stake in the Australian mining company and purchasing minority stakes in some of its units.

MTD has followed the Rio Tinto story over the past 18 months, and in our last article, Rio Tinto: Time For A Package Deal, I suggested that Chinalco might have an opportunity to forge closer ties with Rio Tinto as the miner struggles under a mountain of debt in a time of global economic crisis.

Largely as a result of its purchase of Alcan Inc. two years ago, Rio Tinto is saddled with $38.9 billion of debt that was intended to be paid down through asset sales in 2008 and 2009. Plummeting prices for commodities and mining assets, though, have made such sales all but impossible in the current economic environment. Chinalco, which already owns 9 percent of Rio Tinto’s shares, may lift its holding in the company’s London-listed shares to 18 percent, and buy 14 percent of the company’s Australian-listed shares, under a plan that would raise as much as $15 billion for Rio Tinto.

Ever since BHP Billiton first proposed buying Rio Tinto in November, 2007, I argued that maintaining a free, accessible iron ore market is critical for China. The global iron ore industry is dominated by three players: Brazil’s Companhia Vale do Rio Doce (CVRD), Rio Tinto and BHP. If the merger between BHP and Rio Tinto had gone through, 79 percent of the world’s iron ore supply would find itself in the tight grip of a powerful duopoly, both companies roughly equal in size.

With 500 million tons or more of steelmaking capacity, China accounts for over one-third of global capacity and is, by far, the largest steelmaking country in the world. Unlike ArcelorMittal and U.S Steel, two of the largest companies in the global steel industry, however, China’s steelmakers are not vertically integrated. Therefore, China’s steel industry is vulnerable despite its size because it is caught in the middle—between the powerful iron ore suppliers on the one hand, and a diverse group of customers for steel products on the other. If the deal under discussion between Chinalco and Rio Tinto materializes, Rio Tinto’s existence as a viable, independent iron ore supplier will be all but assured.

If Chinalco increases its stake in Rio Tinto, as it now appears certain, non-Chinese steelmakers needn’t be concerned that a strong shareholding relationship between the world’s third-largest mining company and a large Chinese state-owned enterprise will mean lower iron ore prices for China’s steel companies. Unless Chinalco were to buy 100 percent of the shares of Rio Tinto, the company and its board of directors have a fiduciary duty to ensure that the interests of all shareholders are served, and that the company negotiates the most favorable terms possible with all of its customers, even if several have indirect relationships with its largest shareholder.

Were Chinalco to acquire all of Rio Tinto’s shares, which certainly isn’t in the cards, it still would not give an unfair advantage to Chinese steelmakers. Chinalco has listed shares in overseas markets and its board has the same fiduciary duties to all Chinalco shareholders. Despite the fact that the Chinese government owns significant percentages of Chinalco and the major Chinese steelmakers, all operate as separate economic entities and negotiate accordingly to maximize their individual benefit. As a personal witness to the interactions between state-owned companies in China, I can attest that this is what happens in practice. Human nature being what it is, competitive instincts come to the fore and take precedence over indirect shareholding relationships.

The principal advantage of a larger stake in Rio Tinto by Chinalco for Chinese steelmakers–and to all global steelmakers I would argue–is that it keeps a third major player in the iron ore game. Were Rio Tinto to fall into the hands of either BHP or CVRD, or to be broken up into many smaller pieces, the temptation for the remaining two large players to divide the global iron ore market in two, and enforce monopoly pricing in each, would be too hard to resist. The existence of a viable third competitor will keep price negotiations between buyers and sellers of iron ore more balanced and therefore benefit steel users worldwide.

To be fair, Chinalco’s increased stake in Rio Tinto will give Chinese steelmakers an advantage in the event of iron ore shortages. As long as pricing and other terms are market-based, it would be reasonable to expect Chinese steelmakers to enjoy “most favored nation” status when supplies are tight. This would appear to be a small price to pay in order to ensure balanced price negotiations among the major global players.

At a time when many see China’s rise as a zero-sum game, the developing strategic relationship between Rio Tinto and Chinalco demonstrates how China’s interests and those of other global players need not be mutually exclusive. China is not a monolith, and there are likely to be more win/win scenarios out there than most realize.

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