For those who don’t follow the intricacies of the international iron ore trade, here’s the deal: BHP Billiton, the world’s second largest iron ore supplier recently announced an unsolicited, US$130 billion bid for Rio Tinto, the world’s third largest iron ore supplier (both are Australian). Combined, the two companies would control roughly 40% of the world’s iron ore market. China, as the world’s largest steel maker and iron ore importer, is worried. As things currently stand, Rio, BHP and CVRD (the world’s largest iron ore supplier) function as an effective cartel, setting benchmark prices that rise annually for a hand-picked group of steel makers – including Bao. So, the mere prospect that the cartel of three could be reduced to two has the Chinese steel industry in a panic.
For example: earlier this week, Xe Lejiang, Chairman of Bao Steel, disclosed to a reporter (in an elevator!) that Bao would “very likely” make its own bid for Rio Tinto, and that such a bid would most likely exceed US$200 billion. A few days later, Xu emerged to retract his ill-advised leak, claiming: “I did not say this. It is a fabrication of the media.” Then, today, Fang Xiaodong, senior manager of strategy and planning at Baosteel, offered this nugget to Australia’s ABC radio: “I think the Australian government should take some anti-monopoly action to prevent the merger of BHP and Rio because this kind of behavior will damage free competition.” Not to read too much into this, but – it’s a pretty sure sign of a Beijing flip-out when the state-owned enterprises start talking like free trade advocates.
And on that note, some unsolicited opinions:
* Xe Lejiang is telling the truth when he says that Bao Steel has no plans to buy Rio Tinto. Because, Bao doesn’t have US$200 billion in cash sitting around. And, unlike, BHP – Bao’s inflated stock price and murky state-owned ownership structure isn’t going to appeal to many Rio Tinto investors seeking fair value for their shares. The only way – and I mean the only way – that this deal gets done is if Beijing decides to tap its foreign currency reserves for the US$200 billion. For a little perspective, consider that US$200 billion is the amount of money that China allocated to its new sovereign fund, the China Investment Corporation, earlier this fall. With reported reserves of US$1.43 trillion (as of late September), an investment in Rio would mean that Beijing had drawn down those reserves by 30% in just a few months. Not likely.
* For argument’s sake, let’s say that Beijing is willing to splurge on Rio Tinto, and Rio Tinto is willing to be bought — by the Chinese government and one of its premier state-owned companies. Has anybody bothered to ask the Australian government – or, heck, the Australian voters – how they feel about Chinese government ownership of one of Australia’s largest companies and landholders? I’ve been following this story quite closely, and I’ve yet to see any comments from Australia’s political class on this question. Surely, even with a China-friendly government, someone in Australia has to be uncomfortable about the idea of selling a large percentage of the country’s mines to Chinese ownership – and management?
* I don’t want to belabor this point, but … there is absolutely no chance that the Chinese would ever allow a foreign company to acquire a major Chinese company involved in extraction of natural resources in China. No way, never, not in this lifetime, not in the next. Not oil, not ore, not alumina, not coal, not nothing. This is a one-way street, a one-way market, and the Australians and anyone else involved better wake up to the fact. There will not be – ever – the opportunity for the lucky recipients of the US$200 billion in Chinese funds to move to China and buy, say, Sinosteel (China’s iron ore importing company).
* Concluding on the topic of hypocrisy, let’s review this quote from Fang Xiaodang: “We think the Australian government should take some anti-monopoly action to prevent the merger of BHP and Rio because this kind of behaviour will damage free competition.” For the last five years, roughly, it has been the official policy of China – and the China Iron & Steel Association [CISA] – to reduce the number of steel producers in China. I’ve been attending Chinese steel conferences for the last few years, and at every one – every single one – somebody connected to the CISA gives a presentation with figures on the ongoing consolidation of the industry. The reasons for the consolidation are several, but nobody is shy about pointing out that fewer mills mean better pricing power for the remaining producers – and those remaining producers are almost all state-owned. Bao isn’t interested in free competition; it’s interested in cheap ore. I hope somebody in Australia points that out.
* Finally, in October I published an op-ed with the National Interest that touches on the consolidating Chinese steel industry, and its mercantilist future.